Senate Hearing, 114TH Congress - Federal Reserve's Second Monetary Policy Report For 2015

S. HRG.
11487
FEDERAL RESERVES SECOND MONETARY POLICY

REPORT FOR 2015
HEARING
BEFORE THE
COMMITTEE ON
BANKING, HOUSING, AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED FOURTEENTH CONGRESS
FIRST SESSION
ON
OVERSIGHT ON THE MONETARY POLICY REPORT TO CONGRESS PURSUANT TO THE FULL EMPLOYMENT AND BALANCED GROWTH ACT OF 1978
JULY 16, 2015
Printed for the use of the Committee on Banking, Housing, and Urban Affairs
(
Available at: http: //www.fdsys.gov /
U.S. GOVERNMENT PUBLISHING OFFICE

WASHINGTON
97176 PDF
2015
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L:\HEARINGS 2015\07-16 THE SEMIANNUAL MONETARY POLICY REPORT TO THE CON
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

RICHARD C. SHELBY, Alabama, Chairman
MICHAEL CRAPO, Idaho
SHERROD BROWN, Ohio
BOB CORKER, Tennessee
JACK REED, Rhode Island
DAVID VITTER, Louisiana
CHARLES E. SCHUMER, New York
PATRICK J. TOOMEY, Pennsylvania
ROBERT MENENDEZ, New Jersey
MARK KIRK, Illinois
JON TESTER, Montana
DEAN HELLER, Nevada
MARK R. WARNER, Virginia
TIM SCOTT, South Carolina
JEFF MERKLEY, Oregon
BEN SASSE, Nebraska
ELIZABETH WARREN, Massachusetts
TOM COTTON, Arkansas
HEIDI HEITKAMP, North Dakota
MIKE ROUNDS, South Dakota
JOE DONNELLY, Indiana
JERRY MORAN, Kansas
WILLIAM D. DUHNKE III, Staff Director and Counsel
MARK POWDEN, Democratic Staff Director
DANA WADE, Deputy Staff Director
JELENA MCWILLIAMS, Chief Counsel
THOMAS HOGAN, Chief Economist
LAURA SWANSON, Democratic Deputy Staff Director
GRAHAM STEELE, Democratic Chief Counsel
PHIL RUDD, Democratic Legislative Assistant
DAWN RATLIFF, Chief Clerk
TROY CORNELL, Hearing Clerk
SHELVIN SIMMONS, IT Director
JIM CROWELL, Editor
(II)
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C O N T E N T S
THURSDAY, JULY 16, 2015
Page
Opening statement of Chairman Shelby ................................................................

Opening statements, comments, or prepared statements of:
Senator Brown ..................................................................................................
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WITNESS
Janet L. Yellen, Chair, Board of Governors of the Federal Reserve System ......
Prepared statement ..........................................................................................
Responses to written questions of:
Chairman Shelby .......................................................................................
Senator Crapo ............................................................................................
Senator Vitter ............................................................................................
Senator Heller ...........................................................................................
Senator Sasse ............................................................................................
Senator Menendez .....................................................................................
Senator Donnelly .......................................................................................
ADDITIONAL MATERIAL SUPPLIED
FOR THE
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173
175
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184
RECORD
Monetary Policy Report to the Congress dated July 15, 2015 .............................
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(III)
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FEDERAL RESERVES SECOND MONETARY

POLICY REPORT FOR 2015
THURSDAY, JULY 16, 2015
U.S. SENATE,
URBAN AFFAIRS,
Washington, DC.
The Committee met at 2:32 p.m., in room SD538, Dirksen Senate Office Building, Hon. Richard Shelby, Chairman of the Committee, presiding.
COMMITTEE
ON
BANKING, HOUSING,
AND
OPENING STATEMENT OF CHAIRMAN RICHARD C. SHELBY
Chairman SHELBY. The Committee will come to order.

Today we will receive testimony from Federal Reserve Chair
Janet Yellen. These semiannual hearings are an important part of
the Committees oversight of the Fed and are among the few opportunities that we have for public discussion with the Chair of the
Federal Reserve.
The Fed, as we all know, plays an important role in the overall
economy, both in managing the supply of money and monitoring
the health of the financial system. Through its quantitative easing
and other special programs, the Feds balance sheet has expanded
to an unprecedented size of $4.5 trillion.
To put it in perspective, nearly 20 percent of all Treasury securities20 percentare held on the Feds balance sheet. Furthermore, rather than using the proceeds from matured mortgagebacked securities to reduce its balance sheet, the Federal Reserve
continues to reinvest these proceeds into even more mortgagebacked securities.
In addition, the Federal Reserve continues to hold down interest
rates despite potential adverse effects on the U.S. economy, including the negative impact on household savings.
Past announcements by the Federal Open Market Committee
have stated that it would adjust its interest rate policy once unemployment fell to 5.6 percent. The Feds estimates, however, show an
unemployment rate of 5.3 percent or lower for 2015, and yet interest rates remain unchanged.
The Monetary Policy Report released yesterday states that the
Fed will keep rates low, even though the unemployment rate [will
soon] be at or below its longer-run normal levelwhatever that
means. This is concerning to a lot of people because pushing the
economy beyond its normal level can have negative effects, as we
have seen with economic bubbles in recent history.
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More than ever, the financial markets have become heavily dependent on the Feds monetary policy decisions, which makes
transparency I believe even more important.
The Fed is often described by its own officials as the worlds most
transparent central bankor at least one of the most transparent.
But it is worth noting that in several respects, Federal Open Market Committee monetary policy decisions are less transparent than
at other central banks, including the European Central Bank and
the Bank of England.
For example, the Bank of England has more annual meetings
and a shorter delay in publishing its minutes than the Federal Reserve, and both banks issue more monetary reports per year. In addition, the European Central Bank has twice the number of press
conferences. So it seems that some aspects of the Feds transparency can be improved.
Similar concerns exist regarding the Feds regulatory authority.
The Federal Reserves Dodd-Frank and CCAR stress tests determine the fate of U.S. banks, but the Fed does not reveal exactly
how the banks will be tested or in what ways they have fallen
short.
Similarly, many banks have been forced to file and refile their
living wills without a thorough explanation from the Fed on why
the submissions failed. I believe the Federal Reserve must provide
more complete explanations of its actions in order for the financial
system and the U.S. economy to function effectively.
Chair Yellen, we look forward to your testimony here today and
your appearance and hope that you will be able to shed more light
on some of the questions I have raised.
Senator Brown.
STATEMENT OF SENATOR SHERROD BROWN
Senator BROWN. Thank you, Mr. Chairman, and welcome back to

the Committee, Chair Yellen. Nice to see you again.
Five years ago next week, July 21st, the Wall Street Reform Act
became law. That anniversary serves as an important and ever
present reminder of the costs of the financial crisis. The costs of the
crisis were 9 million jobs lost, an unemployment rate that reached
10 percent, 5 million Americans who lost their homes, $13 trillion
in household wealth erased.
In Ohio alone, unemployment was over 10 percent, and half a
million homes were foreclosed upon between 2006 and 2011. My
wife and I live in Zip code 44105 in the city of Cleveland. In 2007,
I believe, that Zip code had the highest number of foreclosures of
any Zip code in the United States. My State suffered 14 years in
a row of one foreclosuremy entire State, foreclosures more one
year to the next year, every year an increased number of foreclosures for 14 years.
As the Chair of the Federal Reserve, Ms. Janet Yellen, has said,
the unemployed are more than just statistics. Behind each job loss,
behind each foreclosure were painful conversations, parents telling
their children they are going to have to share a house with their
relatives, leaving their neighborhoods, schools, and friends, or that
they could no longer afford their childs education. Think what that
would be like.
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The crisis took a devastating financial and psychological toll on
a generation of workers and their families. We cannot forget that
is why we passed the Wall Street reform law.
Todays hearing is a reminder how far we have come in 5 years.
After unprecedented actions by the Government to stabilize the
economy and the creation of a new regulatory framework to maintain financial stability and protect consumers, the private sector
has created almost 13 million new jobs; household wealth has
grown by some $30 trillion, exceeding precrisis levels; and business
lending has climbed over 30 percent.
This hearing is also a reminder of how important it is that our
financial system remains well regulated for financial stability, for
consumer protection, and to prevent the next crisis. No one wants
to return to the days of 2008 and 2009.
Yet opponents of Wall Street reform continue to say that the law
has not stabilized the economy and even that new regulations will
causewill bring on the next financial crisis. Wall Street reform
did not ruin the economy. Wall Street gambling did, along with the
failure of regulators to take away the punch bowl.
Since Wall Street reforms passage, the economy has strengthened. We have made it less likely taxpayers will get stuck with a
tab for another bailout. Polling released last week shows that
Americans agree with that assessment. They overwhelmingly support strong financial rules.
Some of the behavior in the economy is the product of the extraordinary interest rate environment of the past 7 years. So it is
no surprise that all eyes are on the Fed as it considers its first interest rate increase since 2008. There are real risks in tightening
monetary policy too soon because although the economy has made
progress since the crisis, we still have a ways to go.
The recovery has been uneven. There are many groups of Americans who have not benefited from it. Premature rate increases
could mean these people do not see new jobs, wage increases, or
have access to credit. The current economic problems in Greece and
China also remind us that any progress that our economy makes
cannot be divorced from what is happening overseas. Our manufacturers and our exporters are already contending with a very strong
dollar.
Chair Yellen, I look forward to your assessment of our Nations
economy as well as your appraisal of the progress made from the
enactment and the implementation of Wall Street reform. Thank
you again for joining us.
Chairman SHELBY. Madam Chair, welcome again to the Committee. Your written statement will be made part of the record in
its totality. You proceed as you wish.
STATEMENT OF JANET L. YELLEN, CHAIR, BOARD OF
GOVERNORS OF THE FEDERAL RESERVE SYSTEM
Ms. YELLEN. Thank you. Chairman Shelby, Ranking Member

Brown, and Members of the Committee, I am pleased to present
the Federal Reserves semiannual Monetary Policy Report to the
Congress. In my remarks today, I will discuss the current economic
situation and outlook before turning to monetary policy.
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Since my appearance before this Committee in February, the
economy has made further progress toward the Federal Reserves
objective of maximum employment, while inflation has continued to
run below the level that the Federal Open Market Committee
judges to be most consistent over the longer run with the Federal
Reserves statutory mandate to promote maximum employment
and price stability.
In the labor market, the unemployment rate now stands at 5.3
percent, slightly below its level at the end of last year and down
more than 412 percentage points from its 10-percent peak in late
2009. Meanwhile, monthly gains in nonfarm payroll employment
averaged about 210,000 over the first half of this year, somewhat
less than the robust 260,000 average seen in 2014 but still sufficient to bring the total increase in employment since its trough to
more than 12 million jobs.
Other measures of job market health are also trending in the
right direction, with noticeable declines over the past year in the
number of people suffering long-term unemployment and in the
numbers working part time who would prefer full-time employment. However, these measuresas well as the unemployment
ratecontinue to indicate that there is still some slack in labor
markets. For example, too many people are not searching for a job
but would likely do so if the labor market was stronger. And although there are tentative signs that wage growth has picked up,
it continues to be relatively subdued, consistent with other indications of slack. Thus, while labor market conditions have improved
substantially, they are, in the FOMCs judgment, not yet consistent
with maximum employment.
Even as the labor market was improving, domestic spending and
production softened notably during the first half of this year. Real
GDP is now estimated to have been little changed in the first quarter after having risen at an average annual rate of 312 percent over
the second half of last year, and industrial production has declined
a bit, on balance, since the turn of the year. While these developments bear watching, some of this sluggishness seems to be the result of transitory factors, including unusually severe winter weather, labor disruptions at West Coast ports, and statistical noise. The
available data suggest a moderate pace of GDP growth in the second quarter as these influences dissipate. Notably, consumer
spending has picked up, and sales of motor vehicles in May and
June were strong, suggesting that many households have both the
wherewithal and the confidence to purchase big-ticket items. In addition, homebuilding has picked up somewhat lately, although the
demand for housing is still being restrained by limited availability
of mortgage loans to many potential homebuyers. Business investment has been soft this year, partly reflecting the plunge in oil
drilling. And net exports are being held down by weak economic
growth in several of our major trading partners and the appreciation of the dollar.
Looking forward, prospects are favorable for further improvement in the U.S. labor market and the economy more broadly. Low
oil prices and ongoing employment gains should continue to bolster
consumer spending, financial conditions generally remain supportive of growth, and the highly accommodative monetary policies
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abroad should work to strengthen global growth. In addition, some
of the headwinds restraining economic growth, including the effects
of dollar appreciation on net exports and the effect of lower oil
prices on capital spending, should diminish over time. As a result,
the FOMC expects U.S. GDP growth to strengthen over the remainder of this year and the unemployment rate to decline gradually.
As always, however, there are some uncertainties in the economic outlook. Foreign developments, in particular, pose some
risks to U.S. growth. Most notably, although the recovery in the
euro area appears to have gained a firmer footing, the situation in
Greece remains difficult. And China continues to grapple with the
challenges posed by high debt, weak property markets, and volatile
financial conditions. But economic growth abroad could also pick up
more quickly than observers generally anticipate, providing additional support for U.S. economic activity. The U.S. economy also
might snap back more quickly as the transitory influences holding
down first-half growth fade and the boost to consumer spending
from low oil prices shows through more definitively.
As I noted earlier, inflation continues to run below the Committees 2-percent objective, with the personal consumption expenditures, or PCE, price index up only 14 percent over the 12 months
ending in May and the core index, which excludes the volatile food
and energy components, up only 114 percent over the same period.
To a significant extent, the recent low readings on total PCE inflation reflect influences that are likely to be transitory, particularly
the earlier steep declines in oil prices and in the prices of non-energy imported goods. Indeed, energy prices appear to have stabilized recently.
Although monthly inflation readings have firmed lately, the 12month change in the PCE price index is likely to remain near its
recent low level in the near term. My colleagues and I continue to
expect that as the effects of these transitory factors dissipate and
as the labor market improves further, inflation will move gradually
back toward our 2-percent objective over the medium term. Market-based measures of inflation compensation remain lowalthough they have risen some from their levels earlier this year
and survey-based measures of longer-term inflation expectations
have remained stable. The Committee will continue to monitor inflation developments carefully.
Regarding monetary policy, the FOMC conducts policy to promote maximum employment and price stability, as required by our
statutory mandate from the Congress. Given the economic situation
that I just described, the Committee has judged that a high degree
of monetary policy accommodation remains appropriate. Consistent
with that assessment, we have continued to maintain the target
range for the Federal funds rate at 0 to 14 percent and have kept
the Federal Reserves holdings of longer-term securities at their
current elevated level to help maintain accommodative financial
conditions.
In its most recent statement, the FOMC again noted that it
judged it would be appropriate to raise the target range for the
Federal funds rate when it has seen further improvement in the
labor market and is reasonably confident that inflation will move
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back to its 2-percent objective over the medium term. The Committee will determine the timing of the initial increase in the Federal funds rate on a meeting-by-meeting basis, depending on its assessment of realized and expected progress toward its objectives of
maximum employment and 2-percent inflation. If the economy
evolves as we expect, economic conditions likely would make it appropriate at some point this year to raise the Federal funds rate
target, thereby beginning to normalize the stance of monetary policy. Indeed, most participants in June projected that an increase in
the Federal funds target range would likely become appropriate before year-end. But let me emphasize again that these are projections based on the anticipated path of the economy, not statements
of intent to raise rates at any particular time.
A decision by the Committee to raise its target range for the Federal funds rate will signal how much progress the economy has
made in healing from the trauma of the financial crisis. That said,
the importance of the initial step to raise the Federal funds rate
target should not be overemphasized. What matters for financial
conditions and the broader economy is the entire expected path of
interest rates, not any particular move, including the initial increase, in the Federal funds rate. Indeed, the stance of monetary
policy will likely remain highly accommodative for quite some time
after the first increase in the Federal funds rate in order to support
continued progress toward our objectives of maximum employment
and 2-percent inflation. In the projections prepared for our June
meeting, most FOMC participants anticipated that economic conditions would evolve over time in a way that will warrant gradual
increases in the Federal funds rate as the headwinds that still restrain real activity continue to diminish and inflation rises. Of
course, if the expansion proves to be more vigorous than currently
anticipated and inflation moves higher than expected, then the appropriate path would likely follow a higher and steeper trajectory;
conversely, if conditions were to prove weaker, then the appropriate trajectory would be lower and less steep than currently projected. As always, we will regularly reassess what level of the Federal funds rate is consistent with achieving and maintaining the
Committees dual mandate.
I would also like to note that the Federal Reserve has continued
to refine its operational plans pertaining to the deployment of our
various policy tools when the Committee judges it appropriate to
begin normalizing the stance of policy. Last fall, the Committee
issued a detailed statement concerning its plans for policy normalization and, over the past few months, we have announced a number of additional details regarding the approach the Committee intends to use when it decides to raise the target range for the Federal funds rate.
These statements pertaining to policy normalization constitute
recent examples of the many steps the Federal Reserve has taken
over the years to improve our public communications concerning
monetary policy. As this Committee well knows, the Board has for
many years delivered an extensive report on monetary policy and
economic developments at its semiannual hearings such as this
one. And the FOMC has long announced its monetary policy decisions by issuing statements shortly after its meetings, followed by
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minutes of its meetings with a full account of policy discussions
and, with an appropriate lag, complete meeting transcripts. Innovations in recent years have included quarterly press conferences
and the quarterly release of FOMC participants projections for economic growth, unemployment, inflation, and the appropriate path
for the Committees interest rate target. In addition, the Committee adopted a statement in 2012 concerning its longer-run goals
and monetary policy strategy that included a specific 2-percent
longer-run objective for inflation and a commitment to follow a balanced approach in pursuing our mandated goals.
Transparency concerning the Federal Reserves conduct of monetary policy is desirable because better public understanding enhances the effectiveness of policy. More important, however, is that
transparent communications reflect the Federal Reserves commitment to accountability within our democratic system of Government. Our various communications tools are important means of
implementing monetary policy and have many technical elements.
Each step forward in our communications practices has been taken
with the goal of enhancing the effectiveness of monetary policy and
avoiding unintended consequences. Effective communication is also
crucial to ensuring that the Federal Reserve remains accountable,
but measures that affect the ability of policymakers to make decisions about monetary policy free of short-term political pressure, in
the name of transparency, should be avoided.
The Federal Reserve ranks among the most transparent central
banks. We publish a summary of our balance sheet every week.
Our financial statements are audited annually by an outside auditor and made public. Every security we hold is listed on the Web
site of the Federal Reserve Bank of New York. And, in conformance
with the Dodd-Frank Act, transaction-level data on all of our lendingincluding the identity of borrowers and the amounts borrowedare published with a 2-year lag. Efforts to further increase
transparency, no matter how well intentioned, must avoid unintended consequences that could undermine the Federal Reserves
ability to make policy in the long-run best interest of American
families and businesses.
In sum, since the February 2015 Monetary Policy Report, we
have seen, despite the soft patch in economic activity in the first
quarter, that the labor market has continued to show progress toward our objective of maximum employment. Inflation has continued to run below our longer-run objective, but we believe transitory
factors have played a major role. We continue to anticipate that it
will be appropriate to raise the target range for the Federal funds
rate when the Committee has seen further improvement in the
labor market and is reasonably confident that inflation will move
back to its 2-percent objective over the medium term. As always,
the Federal Reserve remains committed to employing its tools to
best promote the attainment of its dual mandate.
Thank you, and I would be pleased to take your questions.
Chairman SHELBY. Thank you, Madam Chair.
Madam Chair, recently some of us have raised concerns over a
proposal to reduce the statutory dividend paid to member banks on
the shares that they hold in their respective reserve banks to help
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pay for a new transportation bill. Are you aware of some of these
proposals? And do you have some concerns?
Ms. YELLEN. Chair Shelby, I have heard about this proposal, and
I guess I would say I would be concerned that reducing the dividend could have unintended consequences for banks willingness to
be part of the Federal Reserve System, and this might particularly
apply to smaller institutions.
I would also say that this is a change that likely would be a significant concern to the many small banks that receive this dividend.
So I suppose I would say that this is a change to the law that
could conceivably have unintended consequences, and I think it deserves some serious thought and analysis.
Chairman SHELBY. I agree with you, and I do not see any nexus
between the dividends coming from members of the Federal Reserve System, which are a lot of small- and medium-size banks,
and funding the highway or transportation system. I think that is
a pretty far reach, but, you know, people look for money everywhere they can get it. But that is something that I think we better
be working together on, I hope.
In another area, the impact of regulation on liquidity, the issue
of liquidity in the fixed-income market has become a daily topic in
the news and in the markets. Last month, Secretary Lew testified
in the U.S. House that he does notand I will quote him, he does
not believe that Federal regulation is a significant factor contributing to any liquidity issues. It is interesting.
So you think that Federal regulation is a significant factor impacting market liquidity in any respect? And what work has the
Federal Reserve done to determine the impact of regulation on liquidity, if you have, in our markets?
Ms. YELLEN. So I would say that we are studying this issue very
carefully. We have certainly heard the market concerns on this
topic. At this point I can give you a list of factors that may be causing this phenomenon.
Chairman SHELBY. OK.
Ms. YELLEN. I should say you see this decline in liquidity in
some measures but not in others. So the extent of the decline
Chairman SHELBY. But isnt the decline in liquidity an important
issue to be watching?
Ms. YELLEN. So there are a number of things that might be involved. First of all, there have been changes in the structure of the
market. A larger share of bonds are held by buy-and-hold investors
such as insurers and pension funds that may do less trading than
leveraged firms that used to be more dominant in this market. We
have had higher capital requirements and other regulatory
changes, but firms are also changing their own risk management
practices, in some cases in a more conservative direction.
We have seen an increase in algorithmic and high-frequency
trading, and that may be leading to changes in market trading
practices. In addition, in the corporate bond market, there have
been increased reporting requirements that may be reducing the
desired sizes of trades. And I think all of these factors could potentially account for what is going on, but we have not really yet been
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able to figure out what the contribution of each is or just how serious.
I think a concern is that while day-to-day in normal times most
measures of liquidity seem to be roughly unchanged, there is a concern that in stress situations it may be, and we have seen some
cases where it is less available.
Chairman SHELBY. But in any market, you need risk and you
need liquidity, do you not?
Ms. YELLEN. Yes, you
Chairman SHELBY. You do not have a market without it, do you?
Ms. YELLEN. Well, we do need liquidity in markets. There may
be changes, however, that precrisis it was leveraged, even highly
leveraged banks that were exposed to providing liquidity and vulnerable if liquidity were to be reduced. And now it seems like more
of that risk has moved to unleveraged, low-leveraged investors, and
that may be a safer situation. So there are two sides, I think, to
this.
Chairman SHELBY. In the area of reducing systemic risk, which
we all are interested in, do you believe that having fewer systemically risky financial institutions would be a good thing?
Ms. YELLEN. Arguably, yes.
Chairman SHELBY. OK. And should banks through regulation,
like the Fed, be encouraged to reduce systemic risk everywhere
they can?
Ms. YELLEN. Well, we are certainly trying to put in place a set
of incentives that will reduce the systemic footprint and risk of
firms. I think higher capital requirements, we plan to impose surcharges, capital surcharges on the most systemic firms, and other
regulations that will diminish the risks, create incentives for their
footprints to be reduced in ways that will reduce their systemic
risk to the financial system.
Chairman SHELBY. Senator Brown.
Senator BROWN. Thank you, Mr. Chairman.
Madam Chair, I continue to be concerned, as I know you are,
that the economic recovery has not taken hold for all Americans,
notably large numbers of women and in communities of color. I
know that confirmation bias can be a problem in investing, and
some might think it is a bitit might exist on Capitol Hill, too, but
I see lots of evidence of underemployment, unemployment, virtually
no evidence of inflation, and lots of sources of headwinds for our
economy.
What are the risks of tightening monetary policy too soon? And
once rates are increased, what would be the impact of the gradual
rate increases on working Americans?
Ms. YELLEN. So, of course, there are risks to the recovery of
tightening too soon, and we have been highly focused on those
risks. That is an important reason why we have left rates as low
as they are for as long as they have been. Over 6 years they have
been at effectively zero.
We have had a recovery that has been slow to take hold. Growth
has been slower than in most U.S. recoveries following a severe financial crisis. We have clearly made progress. I agree with you
that there remain groups that are struggling in the labor market,
and as we try to show in the Monetary Policy Report, arguably the
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standard unemployment rate that we look at that is 5.3 percent
may somewhat understate the real degree of slack that exists in
the labor market. So we clearly want to see continued improvement
in the labor market, and we want to do nothing that would threaten that.
On the other hand, the labor market is getting demonstrably
closer, in my view, by almost any metric to a more normal state,
and the degree of monetary accommodation has been sufficient over
a long period of time to generate pretty significant improvement in
the labor market. And as the headwinds that are holding the economy diminishand I believe they are diminishingI think it does
become appropriate to beginwe are not talking about tightening
monetary policy. I think we are talking about slightly diminishing
the very high degree of accommodation that we have in place. And,
of course, we would not want to do so in a way or at a pace that
would threaten continued progress in the labor market.
At the same time, inflation is very low, and while we have indicated that a good share of that is for reasons we believe will be
transitory and we expect inflationheadline inflation to rise to
much closer to core levels, that is another reason why we can be
patient in removing accommodation. But I think it is also important there are risks on both sides. Just as we do not want to tighten too soon to threaten the recovery or to jeopardize the return of
inflation back to our 2-percent target, we also want to be careful
not to tighten too late because, if we do that, arguably we could
overshoot both of our goals and be faced with a situation where we
would then need to tighten monetary policy in a very sharp way
that could be disruptive.
My own preference would be to be able to proceed to tighten in
a prudent and gradual manner, and there are many reasons why
I would like to be able to do that. So I agree that there are certainly risks to the recovery and to the labor market of tightening
too soon, but there are risks on the other side as well. We are trying to balance those.
Senator BROWN. Thank you. Some people have suggested recently that American workers need to be willing to work longer
hours. I do not think many Americans work fewer hours by choice
unless, of course, there are health issues or child care limitations
or other responsibilities. I think most or at least many Americans
working part time would like to work full time. This slack in the
labor market seems to indicate we still have a ways to go.
Discuss with us your concern about the number of workers who
are only working part time but would like to be more in the labor
force, if you would.
Ms. YELLEN. Yes. Well, we have an unusually large share of the
labor forceI believe it is around 4.5 percentthat report themselves as working part time for economic reasons. That means they
would like to be working more hours than they are able to work.
And broader measures, the measure of the unemployment rate that
we normally look at, it is referred to as the U3 measure, that is
5.3 percent. But broader measures that capture that part time for
economic reasons, a measure like U6, we have a picture in the
Monetary Policy Report, and we show how high that is. And we
show that although, of course, it is always higher than the nar-
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rower concept of unemployment, it is very much higher than you
would expect historically given the narrower measure of unemployment.
So to my mind, this really suggests that our standard unemployment rate does understate the degree of slack we still have in the
labor market.
Senator BROWN. Thank you.
Thank you, Mr. Chairman.
Chairman SHELBY. Senator Corker.
Senator CORKER. Thank you, Mr. Chairman, Ranking Member. I
appreciate it.
Madam Chairman, thank you for being here. I spent a lot of time
with you when you were getting ready to be confirmed, and I enjoyed that, and I appreciated talking about views on monetary policy. And this is a not a pejorative statement, but I know as you
were coming in, you were acclaimed to be the first dove coming
in as head of the Federal Reserve. I know we had numbers of conversations about that, and I know you supported all of the rate
hikes, on the other hand, that took place as we were leading up.
Ms. YELLEN. That is true.
Senator CORKER. So I want to make sure everybody understands
that.
Ms. YELLEN. Thank you.
Senator CORKER. But we did talk a lot about this moment in
time we are in, and it seems that many are gettinglet me put it
this waythe impression, many who are spending their daily lives
dealing with the stock market, that the Fed has become very affected by the market swings, and that much of that may actually
be driving monetary policy, not just the stats. You know, we have
hadthis is the firstI guess we have had two other times in modern history where we have had negative interest rates, or at least
times that I am aware of, from 1974 to 1976, and 2002 to 2004.
And so we have had this long period of time where, in essence, we
have negative interest rates, and yet it seems the Fed continues to
watch not just the stats, but is very affected by the markets and
worried about disruptions in the stock market.
I am wondering if you might address that.
Ms. YELLEN. So I would push back against the notion that we are
unduly affected by the ups and downs of the stock market. We are
certainly very focused on the fundamentals and the economic statistics that describe where the economy is and in terms of the labor
market and inflation, which are the two goals assigned to us by
Congress, and a lot of different kinds of economic information go
into the forecasts that drive our decision making, our forecasts
about where the labor market and inflation will be moving. But financial conditions broadlyand I am not talking about the stock
market here uniquely, but a wide range of financial variables that
I would say go into assessing financial conditions, the ease for
households and businesses of borrowing that affect their spending
patterns, whether it is consumer spending or investment or our
ability, our competitive position in the global economy that affects
our ability to export and the competitiveness of import competing
goods. The state of financial, conditions broadly speaking, is one
variable that does affect our forecast of the economy.
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So we cannot completely ignore what is happening in the markets to housing prices, to equity prices, to longer-term interest
rates, to credit spreads that influence borrowing costs, to the exchange that affects the competitiveness of U.S. goods and services.
All those factors feed into financial conditions, and they are relevant to forecasting the economy. So it is one element of our evaluation, but I do not think we pay undue attention to it, and I do
not think we should.
Senator CORKER. Yes, I agree. Thank you.
The living will process is something thatI know the Ranking
Member alluded to Dodd-Frank, and Senator Warner and myself
were assigned to work on those particular areas, Title 1 and Title
2, came to an agreement, and actually Senator Shelby, I think, offered an amendment on the floor that passed by 95 votes to make
it even stronger, if I remember correctly. Or at least alter it to
some degree, but certainly make sure it became law.
We have had some questions about the living wills as they have
come up. The last round, there was a little bit of concern, at least
on my part and I think a few others, that there was a little regulatory capture taking place, that really these living wills were way
lacking in substance, and yet maybe the Fed really was not, you
know, putting the pressure on these organizations to deliver as
they should.
I had a good meeting this week with Mr. Tarullo, and my understanding is the substance of these living willsI know you all have
sent out some statements regarding what has happened. I think
they are much better than they have been. But it is pretty clear
these living wills have to be able to resolve an institution under
bankruptcy, and I just wonder if you might speak to that for a moment.
Ms. YELLEN. I agree with you. We worked closely with the FDIC
in this last round a year ago to set out a clear set of expectations
for what we want to see in the current round of submissions. We
have worked closely with the FDIC and the banking organizations
to make sure that they have been very clear about what we expect
in this round of submissions. We have instructed them to enhance
their disclosure in the public part of the documents that they
produce, and it looks like preliminary reads suggest they have
made progress there, and we are going to be evaluating them in
the coming months, and we indicated that if we continued to see
shortcomings in the living wills, we will use our authority to determine that these resolution plans do not meet Dodd-Frank requirements. And that is where we stand, and that is what we are going
to do.
Senator CORKER. Thank you very much for your service. I appreciate it.
Senator CORKER. Thank you, Chairman.
Chairman SHELBY. Senator Menendez.
Senator MENENDEZ. Thank you, Mr. Chairman.
Madam Chair, thank you for your service to our country. I appreciate the work you have been doing.
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Senator MENENDEZ. As you know and have stated many times,
the Feds dual mandate directs it to pursue maximum employment
and stable prices. Now, how the Fed chooses to balance these goals
has significant consequences for the quality of life of millions of
Americans.
On the first element, our labor market is improving, but most
Americans feel like they have a lot of catching up to do from the
deep hole the financial crisis put us in. They do not feel that their
personal circumstances have certainly risen at all, and they feel
enormous challenges.
Meanwhile, inflation continues to run well below target, as it has
for an extended period of time, so it would be a mistake in my view
for the Fed to shift its focus away from jobs at this critical time.
With interest rates near zero, the Fed has essentially no room for
error if it tightens too soon. If it tightens too late, I think the risks
are much lower, and the Fed has plenty of ammunition to keep inflation anchored.
So as a follow-up to Senator Browns question, I would like to
know, in order to avoid choking off economic growth prematurely,
will the Fed wait to raise interest rates until after it has seen signs
of actual inflation rather than based on some intangible fear of future inflation, which may or may not ever actually materialize?
Ms. YELLEN. So, Senator, I agree with your characterization of
the risks that if there is a negative shock to the economy within
interest rates pinned at zero, we do not have great scope to respond
by loosening policy further; whereas, with a positive shock, of
course, we can tighten monetary policy. We have the tools, and we
know how to do that. That is a consideration that has been weighing on our decision making for quite some time and has led us in
part to hold interest rates at these very low levels for as long as
we have.
So that has been a factor we have been taking into account, and
it partly explains the policy that we have been following. But there
are lags in the effect of monetary policy. We need to be forwardlooking. And on the other side, there are risks from waiting too
long to act as well. We have to balance those risks.
You asked me if we would likely raise rates before inflation has
risen substantially, and there I would point you to Section 3 of the
report that we gave to you where we show each summary of their
forecast for the economy and for policy. And as I mentioned in my
testimony, most participants, as of our June meeting, envisioned
that economic developments would proceed in a way for the rest of
this year that would, in their view for almost all of them, make it
appropriate to begin the process of normalizing policy sometime
this year.
And if you look at their inflation forecasts, at the end of the year,
on a year-over-year basis, most participants envisioned that total
inflation would be running a little bit under 1 percent, so that is
well below our 2-percent objective. And they envisioned core inflation, that is, for the year as a whole, at the end of 2015 as running
in the neighborhood of 1.3 to 1.4 percent. So in that sense, you can
see in their projections that they are envisioning its being appropriate to begin tightening policy within inflation below our objective. But what we have said is we want to have reasonable con-
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fidence before we tighten that inflation over the medium term will
move back to 2 percent. And what is going on here is that we think
that there are transitory influencesnamely, the marked decline
in oil prices and the strengthening of the dollarthat are holding
inflation down, and that underlying inflation, even with core inflation, that low import prices and declining import prices are a transitory factor holding that down, that as we see the labor market
improve and these transitory influences wash out, that we believe
that inflation will move back to 2 percent. And so if we have that
confidence, the Committee would be likely to begin before seeing
inflation go back up to our target.
Senator MENENDEZ. Now, normally in my experience here I
would have interrupted you a long time ago because my time has
expired. But because your response was so interesting and I am
trying to grasp where your policy view is from it, I let it go.
Let me, if I may, just make one very brief comment, Mr. Chairman, and that is, from myI listened to you intently. From my
perspective, I think it is much less of a problem that inflation may
run high a little bitI did not say significant inflation, which you
referencedto run high for a little bit, for a short period of time
until the Feds response to it takes effect than the alternative,
which is cutting off much needed job growth and income growth,
too, which would have been my second question, but I will submit
that for the record.
Ms. YELLEN. We do not want to cutoff job growth and income
growth, and we do want to see inflation move up to 2 percent. We
would not be pleased to see it linger indefinitely below 2 percent.
Senator MENENDEZ. Thank you, Mr. Chairman.
Chairman SHELBY. Senator Rounds.
Senator ROUNDS. Thank you, Mr. Chairman.
Madam Chair, recently the Senate Banking Committee held a
hearing that examined the role of the Financial Stability Board in
the U.S. regulatory framework. A lot of concern was expressed
about international decision making on regulation overtaking U.S.
decision making. I am just curious if you would agree that it is important for the United States to set its own insurance capital and
other regulatory standards before agreeing to any such standards
internationally.
Ms. YELLEN. Well, we are working on U.S. standards. Nothing
applies to U.S. firms until we have gone through a formal rulemaking process or process with orders in the United States. So no
international discussion or agreement applies to U.S. firms unless
they are consistent with U.S. law and we have gone through a fullblown rulemaking process.
But discussions are taking place internationally about appropriate standards. I think it is very important that we weigh in on
those discussions so that the standards that other countries adopt
work for our markets and for our firms, and that we end up with
a playing field that is competitive for our own firms to compete in.
So we participate in those international discussions, but within an
understanding that nothing applies to U.S. firms until we have
gone through a full rulemaking process here.
Senator ROUNDS. Thank you. I would like to follow up just a little bit on what the Chairman was visiting with earlier, and that
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is with regard to SIFI designations, literally in the spirit of reducing systemic risk. Do you support giving designated firms a specific
road map for de-designation, like an off ramp or an approach that
would allow them to basically de-certify?
Ms. YELLEN. So I think firms should have the ability to de-certify, and the FSOC every year has to review designations to make
sure that they remain appropriate. That is an annual procedure.
Now, firms are given very detailed information and interact a
great deal with FSOC during the process of designation, and they
understand very clearly what it is about their business model and
strategy that has caused them to be designated. So it is not a mystery to those firms what about their business activities is responsible for designation.
I do not think it is appropriate for FSOC or for the regulators
to try to run these businesses, to try to micromanage what these
firms do. I do not think there is any single, appropriate off ramp.
We should not be telling them exactly do the following list of
things. They understand what they need to do to change their profile in a way that would change FSOCs evaluation. And if they
were seriously contemplating making those kinds of substantial
changes, I am sure there would be many opportunities to interact
with FSOC and staff to gain some perspective on whether or not
the kinds of changes they were thinking of would significantly
change their systemic footprint.
Senator ROUNDS. Thank you.
One last question. As you know, Madam Chair, when you talk,
the markets clearly listen. As you work with the Federal Reserves
Open Markets Committee, you look at a balanced approach, and
you are looking at several goals. You have clearly defined that your
goal is a 2-percent inflation rate. What about when we talk about
maximum employment? Where do we go, and what do you lay out
as the firms look at it in terms of what to expect from the Committee? What is your goal in terms of the maximum employment?
Ms. YELLEN. So as we say in our statement of longer-run goals
and monetary policy strategies, there is something different about
the two goals. We have a goal for inflation, 2 percent, and maximum employment. A central bank can choose or determine what
its inflation target should be. We chose 2 percent. We are in good
company. That is what most advanced central banks have chosen.
Maximum employment is different. We cannot just decide what
do we want that to be in the long run. We think there is some normal longer-run rate of unemployment or level of maximum employment that is consistent with stable inflation, and for us it is not
something we can say we would like it to be this or we would like
it to be that. It is something we are trying to determine. It can
change over time. It is not easy to know exactly what is possible
given technology and demographics and the way the institutions of
the labor market function. So we are trying to estimate it, not determine it.
But participants in the Committee are asked every 3 months,
when they submit their forecasts, to write down their own current
views on the unemployment rate that corresponds to what they regard as normal in the longer run or consistent with maximum employment. And most members of our Committee or participants
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currently regard that as an unemployment rate in the neighborhood of 5.2 to 5.3. And that is something that can change over
time. It has changed over time, and we report that publicly.
Senator ROUNDS. Thank you.
Chairman SHELBY. Thank you, Senator Rounds.
Senator Donnelly.
Senator DONNELLY. Thank you, Mr. Chairman, and thank you,
Madam Chair.
Madam Chair, I know you share my concerns with income inequality and the continuing trend of middle-class wage stagnation.
In your testimony, you said, . . . although there are tentative
signs that wage growth has picked up, it continues to be relatively
subdued . . . .
So as the economy improves, how do you expect middle-class
wages to show substantial improvement? What are you looking at?
Ms. YELLEN. Well, we look at several different measures of wage
growth. Three aggregate measures that we look at are the Employment Cost Index, hourly compensation, and average hourly earnings. They do not always tell exactly the same story. I think we
have seen a meaningful pickup over the last year in the growth in
the Employment Cost Index but less movement in the other two
measures. So there are early indications or conflicting indications
there.
The levels of increase are still relatively low, and in real or inflation-adjusted terms, compensation or wages are increasing less rapidly than productivity.
Senator DONNELLY. What do you expect to see in the next
year
Ms. YELLEN. I would expect to see
Senator DONNELLY. with regard to middle-class wages?
Ms. YELLEN. a pickup inso I am not going to say middleclass wages but aggregate wages in the economy. I would expect
to see some further upward movement. Where they can go depends
in part on productivity growth. For example, if productivity
growthand there is a lot of uncertainty about what it is, but if
it were at a trend rate running, say, around 1.5 percent with a 2percent inflation, we would expect to see wage growth
Senator DONNELLY. And I guess the key to that is that there
would actually be some correlation between productivity growth
and the growth in wages as well.
Ms. YELLEN. There tends to be over long periods of time, but it
is not always true over shorter periods. So there is some uncertainty about this, and we have been through a period in which
wages have been in real terms
Senator DONNELLY. We have not seen a closer link
Ms. YELLEN. growing less rapidly than productivity. I would
expect to see a pickup. It is not a certainty here, but it isand to
my mind, it is evidence of some remaining slack in the labor market. So that ismy forecast is that we will see some pickup in
wage growth.
But it is important to remember that there has been increasing
wage inequality in the United States over a long period of time,
certainly going back to the mid-to-late 1970s, and that reflects a
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deeper set of structural factors that the Federal Reserve does not
have tools to combat. What we are looking for is an overall job
market that is functioning in some sense well, but we see increasing gaps between the wages or compensation of more skilled and
less skilled workers, and that has been holding down middle-class
wage growth for a long time for other reasons.
Senator DONNELLY. Let me ask you about a little bit different
subject. You know, I voted for Dodd-Frank because I wanted to see
safety and stability in the system. It was not a desire to load it up
with regulations, but it was a desire to make sure we had safety
and stability. But now what we have seen is a growing shadow
banking system, which brings other concerns, and so as you look
at this, since shadow banking entities are not subject to the same
regulatory oversight, how concerned should we be with the potential risk involved here? Because that is what we are trying to drive
at in the first place with Dodd-Frank, was to eliminate some of the
systemic risk.
Ms. YELLEN. Well, I think you have put your finger on a very important phenomenon, and we were well aware when we put these
regulations in place in Dodd-Frank that wherever you draw the
regulatory perimeter, there will be a tendency for activity to migrate beyond it to what we call the shadow banking system. So
we clearly need to be very vigilant about monitoring risks that are
migrating to that system, and certainly in the Federal Reserve, we
have hugely ramped up our attention to the shadow banking system.
The FSOC is focused on risks developing broadly through the financial system in shadow banking, and the Financial Stability
Board has a large work program devoted to shadow banking. We
are thinking about regulations that might addresslike minimum
margin requirements that would apply not only to banking organizations but more broadly, that might address some potential risks
in the shadow banking system.
Of course, we have seen some heightened attention to risks by
the SEC in money market funds, which was an important piece of
the shadow banking system where risks developed leading to the
crisis. But you are absolutely right to focus on that, and we are attempting to address those risks as best we can.
Senator DONNELLY. Thank you, Madam Chair.
Chairman SHELBY. Senator Scott.
Senator SCOTT. Thank you, Mr. Chairman. Chair Yellen, thank
you for being here today.
Senator SCOTT. As I travel across South Carolina, people express
concerns about America leading from behind, whether my conversations with folks have been about the Administrations failure to enforce their own red lines in Syria or more recently about the illadvised nuclear deal with Iran, South Carolinians have the sense
that our Nation is timid, that it is comfortable sitting back and
taking cues from foreign actors rather than occupying our traditional role a leader of the world.
Now, I am certainly not suggesting that you somehow are in
charge of military policy or Middle East diplomacy, but you are in
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charge of our regulatory policy for some of our countrys most successful businesses. And sometimes it seems to me like our U.S. regulators are leading from behind, especially when it comes to our involvement in international regulatory bodies like the Financial Stability Board or the International Association of Insurance Supervisors.
For example, the FSOC designated domestic insurers as SIFIs
shortly after the FSB did, suggesting that the FSOC was happy to
follow FSBs lead.
We saw something very similar happen with capital buffers for
money market mutual funds. The FSOC and SEC seemed to take
their cues from the FSB.
Madam Chair, now that the Fed is writing a capital rule for insurance companies, I would encourage you to break from the tradition of leading from behind by developing a capital standard that
first works for our domestic insurance companies rather than letting international standard-setting bodies like the ones I have mentioned already write rules and export them back to our country.
I would also encourage you in your capacity as a member of the
IAIS to take the lead in that body in promoting activity-based regulations of insurers as the group reconsiders its GSII designation
methodology later this year. It appears that Governor Tarullo has
committed the Fed to an activities-based approach for asset managers, but I have not yet heard him say that he would do the same
for insurers.
Can you commit today that the Fed will take the lead and follow
these two courses of action both on insurance company capital
standards and on promoting the replacement of entity-based regulation of insurance with activity-based regulation? I think Senator
Rounds really was starting down this road when he was asking his
question. It appears to me that the European regulators are concerned about the creditor protections. We at home are far more
concerned about protecting the policy holders. The difference yields
different capital philosophies. I would like a commitment to use our
domestic approach and export it as opposed to importing their philosophical disposition on capital standards based on creditor protections.
Ms. YELLEN. So I guess all I can really say is that we are playing
an active role internationally in insurance, which is why we joined
the IAIS. We are participating jointly with the Federal Insurance
Office and the State Insurance Commissioners. We are collaborating to think through what is an appropriate system of capital
and liquidity standards for globally active firms.
We have a strong interest in doing that, and it is important for
us to have our voices heard in that process. So I do not think it
is accurate to say we are sitting back and not trying to play a leadership role. I think we are.
Domestically, we have been given increased flexibility through
the Collins fix to design and tailor a set of insurance regulations,
capital standards that we think are appropriate for our institutions. We want to carefully tailor them to the unique characteristics of the firms that we supervise, and we are taking the time and
interacting with those firms to make sure we understand what an
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appropriate insurance-centric, well-tailored set of capital standards
would look like.
Senator SCOTT. Thank you. I think at the end of the day all of
the Washington regulators speak and sound pretty academic, but
what it ultimately boils down to is a price that Americans will pay
for their retirement. One of the things that we are trying to do is
make sure that that price goes down and not up as we find ourselves, from my perspective, adopting international standards as
opposed to taking ours and exporting them.
Thank you.
Chairman SHELBY. Senator Warren.
Senator WARREN. Thank you, Mr. Chairman, and it is good to see
you again, Chair Yellen.
I want to follow up on Senator Corkers question. As you know,
Dodd-Frank requires big financial institutions to submit living
wills, a plan for how they could be liquidatedand I want to quote
the statute herein a rapid and orderly fashion in bankruptcy
without bringing down the economy or needing a taxpayer bailout.
Now, by law, the Fed and the FDIC are supposed to determine
whether these plans are credible or not, and then if they are not
credible, the agencies can order the institutions either to simplify
their structures or eventually to sell off assets.
So last August, the Fed and the FDIC identified significant problems with the living wills submitted by 11 of the biggest banks in
the country. The FDIC determine that these living wills were not
credible. But the Fed did not. Instead, the Fed said that if the
banks did not take immediate action to improve their resolvability
and reflect those improvements in their new living wills, the Fed
expected to find the new living wills were not credible.
Now, the 11 banks submitted their new living wills at the beginning of this month, and I know you have not completed reviewing
them yet. But I just want to make sure we are really clear on this
point. Will the Fed find living wills not credible if the bank has not
fixed each of the problems that the agencies identified last August?
Ms. YELLEN. We are certainly prepared to make those determinations. We will work jointly with the FDIC, as we have been doing,
to analyze the living wills and see whether or not we feel that the
responses to the directions that we gave to these firms are satisfactory or not. And if we find that they are not, we are certainly prepared to say that they are not credible.
Senator WARREN. OK. Good. I am glad to hear that.
Two of the issues the agencies directed the banks to address
were establishing a rational and less complex legal structure and
developing a holding company structure that supports resolvability.
Now, JPMorgan Chase, just to pick one example, has over 3,000
subsidiaries. It will take a lot of work to establish a rational structure that permits JPMorgan to be resolved quickly as required by
law. But to be clear again, the Fed will find JPMorgans living will
not credible, and the living wills of the other 10 banks not credible,
if they have not taken concrete steps to significantly simplify their
structures and are not sleek enough to be resolved quickly?
Ms. YELLEN. Well, we have given them those directions, and we
will evaluate that. I would simply say that the regulatory reports
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that we receive indicate that these firms since 2009 have reduced
the number of legal entities in their structures by approximately
a fifth. I guess we will be looking for
Senator WARREN. You will note that number I gave you is not
from 2009. It is over 3,000 subsidiaries at latest count that I have
seen. So I just want to be clear that you are willing to say not credible if they do not meet the legal standards that they could quickly
be resolved, and that includes how complex their structure is.
Ms. YELLEN. Well, agreed that they need to be less complex, and
we have given them that direction. But I am not sure we can determine exactly how complex they are by just counting the number of
legal entities
Senator WARREN. Fair enough. I am glad to have
Ms. YELLEN. They are not all
Senator WARREN. lots of ways you look at this.
Ms. YELLEN. They are not all equal. Some are set up for very
narrow purposes and would not represent serious impediments to
resolving the firms. So I do not want to
Senator WARREN. OK. But
Ms. YELLEN. determine this by count of legal entities.
Senator WARREN. Count by itself, I understand that. But we do
remember that the statute says rapid and orderly liquidation, and
that goes to the question of complexity. I raise this because the living wills are one of the primary tools the Fed has to make sure
that taxpayers will not be on the hook if one of these giant banks
fails. It is critical that the Fed uses this authority, and like the
FDIC has been willing to do, to make our financial system safer.
I want to ask you one other question just quickly. In DoddFrank, Congress directed the Fed to impose some tougher rules on
banks with more than $50 billion in assets. That covers roughly 40
of the biggest banks in the country, about one-half of 1 percent of
the 6,500 banks that we have in the U.S. Together, this one-half
of 1 percent holds more than $14 trillion in assets, about 95 percent of all the banking assets in this country40 banks, 95 percent
of all the assets.
The tougher scrutiny is designed to direct regulator attention
where serious risk isin other words, concentrate regulatory scrutiny on these 40 banks rather than on community banks and credit
unions.
Now, there have been proposals recently about exempting many
of these banks from tougher rules by raising the $50 billion threshold to $100 billion, $250 billion, $500 billion. The argument I hear
is that $50 billion banks just do not pose systemic risk. So I just
want to ask a question on this one.
We learned or should have learned in 2008 that in a crisis several banks can find themselves on the verge of failure at the same
time. Do you think it could pose a systemic threat if two or three
banks with about $50 billion in assets were on the verge of failure?
Ms. YELLEN. Well, when a significant number of firms is at the
risk of failure, often it is because they have highly correlated positions. We always have to worry about that resulting in a drying up
of credit to the economy, and, you know, during the Great Depression, most of the banks that failed were small. They were a lot
smaller than $50 billion or adjusted for that time. So when many
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banks fail, of course, we have to be concerned as well, and that is
one reason why for all institutions, even for community banks,
Basel III regulatory capital requirements are higher. We want to
see safety and soundness throughout the entire financial system,
throughout the banking system, although the most systemic firms,
as you pointed out, of course, need the greatest scrutiny.
Senator WARREN. It is the top 40. So I just want to say there are
two approaches to this issue. The first, which every Republican on
this Committee supported, is to raise the threshold to $500 billionthat is, cut loose about 30 or so of the biggest banks in this
country, and just hope for the best. And if it does not work out, the
taxpayers can pick up the tab again.
The other approach is to play it safe. Keep the threshold where
it is and rely on the Fed to tailor the rules to fit the risks posed
by these different banks. That is the approach I support, and since
the American taxpayers are on the hook when the economy starts
to implode, I suspect most of them would prefer that Congress be
careful, too. Thank you, Madam Chair.
Chairman SHELBY. Madam Chair, some people have proposed
that we do not have any threshold. You have seen some of that.
But the regulator having the power to do their job properly, you
have seen some of that, I am sure.
Senator Crapo.
Senator CRAPO. Thank you very much, Mr. Chairman, and I
want to follow up on exactly the same question that Senator Warren just finished on.
Last September, I asked Federal Reserve Governor Tarullo about
legislatively raising the trigger when a bank is systemically important from the $50 billion level. In hearings, we have heard that the
asset threshold should be raised or changed because it is arbitrary,
includes institutions that are not systemically important, focuses
only on size, and produces undesirable incentives. Governor Tarullo
said that several years of testing and assessment have given regulators a better understanding of the designation threshold. Given
the intensity and complexity of work around stress testing, he said
that regulators have not felt that the additional safety and soundness benefits of SIFI regulation are really substantial enough to
warrant the kinds of compliance and resource expenditures required of banks that are above $50 billion in assets, but well below
the largest systemically important institutions.
And so I guess my question to you, which is sort of another way
of asking the same question that Senator Warren just asked, is: Do
you agree with Governor Tarullos analysis that there would be a
benefit if Congress changed the current threshold and focused more
on substantive evaluations of true risk rather than on an arbitrary
number?
Ms. YELLEN. So like Governor Tarullo, I would be open to a modest increase in the threshold. And I guess the reason that I would
be open to it is, as he indicated and as you just stated, we do have
some smaller institutions that under Section 165 are required to
do, for example, supervisory stress testing and resolution planning.
And for some of those institutions, it does look from our experience
like the costs exceed the benefits.
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But if there were to be a modest increase in the threshold, I
think what is essential is that the Federal Reserve retain the discretionary to subject an institution that might fall below the new
threshold to higher supervisory requires, for example, that we
would be able to insist that it perform supervisory stress testing if,
in our view, the risk profile of that firm, in spite of its size, led us
to believe that it had systemic import that made us think it was
appropriate, and that is possible that we might feel we would need
that discretion. But at present, every firm over $50 billion has to
do things like supervisory stress testing, and I think what we have
found is in some cases the burden associated with that for many
of those firms really exceeds the benefit to systemic stability. But
retaining the discretion to, as supervisors require them to, do that
if we thought it appropriate, that would be very important for me
to support that change.
Senator CRAPO. Thank you. I appreciate your openness to increasing the threshold and focusing on the flexibility that we need
there. What I am hearing you saywell, let me put this differently.
It seems to me that a principle we should follow is that banks with
similar risk profiles should not be subject to different regulatory
standards, and that applies on both sides of any arbitrary number
which we might pick. The question that Iwhat I think I heard
you say was that the real issue is the risk profile, and that the regulators should have the authority to evaluate the risk profile of our
financial institutions and regulate them appropriately. Did I hear
you correctly?
Ms. YELLEN. I think that is a fair summary.
Senator CRAPO. Thank you. And the last question I have is: The
Office of Financial Research recently published a study this past
February that uses a multifactored approach to grading the systemic risk of each of the institutions subjected to Section 165 of
Dodd-Frank. Are you familiar with that study? Do you know what
I am referring to?
Ms. YELLEN. I am sorry. I have not really had a chance to review
the study. I apologize.
Senator CRAPO. Fair enough. I get asked by reporters all the
time about things, and I have learned, if I do not know about it,
to tell them, and I appreciate that.
The point is this study showed that different banks who are subject to the $50 billionwho are on the upside of the $50 billion
trigger have vastly different risk profiles. And I guess the question
I was going to ask you is whether this study has validity in showing that there are vastly different risk profiles among the different
banks who are above the $50 billion trigger. So let me ask that
question without referencing the study.
Isnt it correct that there are very, very different risk profiles in
this pool of banks that are above the $50 billion trigger?
Ms. YELLEN. Yes, they have very different risk profiles. Some are
essentially large community banks that are not especially risky.
But, on the other hand, we have a couple of U.S. firms that are
designated as GSIBs now. They are a lot above 50, but they are
certainly a lot smaller than the largest U.S. firms. But they have
business models that make their activities systemically important.
And so firms of the same size can have very different risk profiles
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and the appropriate supervision of those firms can be quite different.
Senator CRAPO. Well, thank you. And this is not a question. I
will just conclude with this comment, and that is, I think we would
be much better served if our regulatory system allowed our regulators to focus on risk and regulate to that rather than forcing
them to utilize arbitrary numbers.
Chairman SHELBY. Thank you, Senator Crapo.
Senator Reed.
Senator REED. Well, thank you very much, Mr. Chairman. Just
quickly, because I have had the opportunity to listen to these questions, your position would be that a threshold is appropriate, but
then discretion to look at different banks over that threshold differently is what really you think is the ideal?
Ms. YELLEN. Well, within limits, we can tailor our supervision to
the profiles of the firms. I guess I would be concerned if the threshold is raised, we are now saying that banks that used to be above
the threshold now fall below the new threshold. They are no longer
automatically subject to a number of requirements.
Senator REED. And they might be engaged in risky behaviors
that
Ms. YELLEN. Yeah, and we might want to, as supervisors, say no,
no, no. But those two firms, they really need to continue doing
that. We know they are now below the threshold, but we want to
subject them to it anyhow because it is right for them.
Now, there may be many other firms that have now been relieved from what was a burden that is not appropriate for them.
Senator REED. So just to be clear, this issue of threshold is not
to essentially if you get below a threshold, you do not have any responsibility. What you want to be able is to follow risk even if it
is below the threshold.
Ms. YELLEN. That is right. But we have observed that, for example, quite a number of firms that are just above the $50 billion
threshold, we are really imposing some burdens on them that it is
not clear that the benefits exceed the costs there.
Senator REED. Just a final point. There is sort of a functional
value of having a threshold.
Ms. YELLEN. Yes.
Senator REED. However you want to characterize it, because if
you do not, then you have to have sort of a contest with each institution about whether they fit within your criteria, whether they
truly have risk, and you do not have the entree you need to basically make your valuation. You know, you have to fight your way
through the door. Is that correct?
Ms. YELLEN. That is right. And I used the words modest increase in the threshold.
Senator REED. All right. Thank you.
My real question is with the now ubiquitous issue of cybersecurity. First, a two-pronged question. One is the cybersecurity of the
Federal Reserve, and then as importantly, maybe more importantly, how effective you are in ensuring that your regulated institutions have cybersecurity protections that are effective, because
this is the issue of the moment and of the next decade or more
millennium maybe.
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Ms. YELLEN. Absolutely agreed. We internally are highly focused
on cybersecurity. I believe we have a robust and comprehensive cybersecurity system in place. We realize that the nature of the
threats we face are constantly evolving. We are routinely doing
self-evaluations of our vulnerabilities and engaging third parties to
review what we are doing.
We have a National Incident Response Team that is constantly
24/7 responsible for looking at intrusion detection, incident response, vulnerable assessments, trying to do their own penetration
tests to see how secure we are. We have business continuity plans
for all of our business lines, including our most systemically important payment systems like Fedwire and for our open market operations. If the primary operators of these systems were to suffer an
attack, we have backup facilities that could take over the operations. So that is sort of a
Senator REED. Madam Chair, switching to your regulated industry, are you testing them as hard? Are you going in with teams to
assess? Are you trying to sort of break inI mean, in terms of as
a regulator looking to see if they are conducting operations appropriately?
Ms. YELLEN. So I do not think we are breaking in and doing our
own detection tests. But it is an important aspect of our supervision to ensure financial institutions have appropriate measures
in place. We have specialized teams of supervisors that are trained
in IT security who examine the institutions to make sure that they
are appropriatelytaking the appropriate steps, and we work jointly with other regulators through the FFIEC for the financial sector
more broadly under the leadership of Treasury. And we support efforts throughout the Government to make sure that we are addressing these threats.
Senator REED. Thank you very much. I think the nature of the
threat is we will be having this conversation for a long time.
Ms. YELLEN. We will.
Chairman SHELBY. Senator Warner, finally.
Senator WARNER. Thank you, Mr. Chairman. I will go ahead and
start.
Chairman SHELBY. I am sorry. If I could, Senator Schumer came
back.
Senator SCHUMER. I will let Senator Warner go.
Chairman SHELBY. He was here earlier. He came back.
Senator WARNER. Senator Schumer was hoping to learn from
some of my comments, and then he can follow up on them.
Chairman SHELBY. He yielded to you, so maybe we will
Senator SCHUMER. Mark, do not mess with me.
[Laughter.]
Senator WARNER. I want to start by complimenting the Chairman on one of his first questions to Chair Yellen about the notion
of taking some of these funds that are used to shore up the financial system and using them for purposes not related to the financial
system, the way I believe some people have proposed related to
highways.
This is what happens when you skip the line in the hierarchy on
the Democratic side.
[Laughter.]
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Senator SCHUMER. Those are the big banks.
Senator WARNER. Although I would acknowledge that while I
have great sympathy, you know, for the fact that our communitybased banks, close to 7,000 of them, are buying into this, getting
the 6-percent return, you know, some of the money market funds
that can access the emergency window at 50, 60, 70, 80 basis
points, if they have to then get this ability to invest at 6 percent,
that is a pretty good trade for the money center banks that the
community banks do not have
Senator SCHUMER. I am going to forgo my line of questioning.
[Laughter.]
Senator WARNER. The one thing I know that I think Senator
Warren and probably Senator Brown offered, I actually do believe
on the resolution plans that we have made progress and that we
are seeing plans with greater rigor and, candidly, even some of the
plans in terms of the capital standards that are being put in place
might even get close to meeting Senator Brown and Senator
Vitters requirements.
The one area that we still do not have the regs out on, though,
is the regs on the long-term debt and how we have got to make
sure that that long-term debt is clear, that it could be convertible
in the event of a challenge so that we can use bankruptcy, so that
we can meet the goals that Senator Brown so carefully articulated.
I think what I would love to just hear is some assurance that we
are going to see those final regs by the end of the year so that we
can have this full guidance out about these resolution plans.
Ms. YELLEN. So I cannot give you a specific date, but I want to
assure you it is a very high priority item for us. We have not
Senator WARNER. Chair Yellen, I did not say specific date. I am
just saying end of the year. You know, that gives you half the year.
Ms. YELLEN. I am loath to promise a date. This is really important to us. This is not something that we are just letting slip. It
is right at the top of our agenda
Senator WARNER. But when we look at
Ms. YELLEN. to get this done.
Senator WARNER. the capital structures and the kind of increased ability for these large banks to withstand trauma, having
those rules out on the long-term debt and that conversion component really, you know
Ms. YELLEN. Agreed. I totally agree.
Senator WARNER. Because I really want to be able to respond to
Senator Brown in an artful and complete way that his approach
maybe has been solved by those of us who thought Title 1 and Title
2 got at this issue.
Ms. YELLEN. So we completely agree. It is very important for
there to be a long-term debt requirement. Most of these firms in
their living wills propose a resolution strategy that is similar to the
FDICs single point of entry strategy that they would use under
Title 2.
Senator WARNER. Right.
Ms. YELLEN. In either case, it requires adequate long-term debt.
We are working jointly with the FDIC trying to figure out the right
parameters. We are working through the FSB. There is a TLAC
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agreement. We want to see this globally. I promise to get it done
just as soon as we can. I am not going to let it
Senator WARNER. It sounds likeend of the year sounds like a
great time. But let me
Ms. YELLEN. I promise to make every effort to do so.
Senator SCHUMER. He has spoken.
[Laughter.]
Senator WARNER. You know, one of the things that we have
seenlet us switch to kind of world monetary policy for a moment.
You know, as we see the Bank of Japan and the ECB continue to
deal with their currencies, which indirectly obviously makes their
products cheaper, our products more expensive, do you worry at all
that the actions of these other central banks are putting even more
undue pressure on America to be the engine that drives and affects
the whole worlds economy because of their monetary policy actions?
Ms. YELLEN. Well, monetary policy for domestic purposes often
has some impact on a countrys exchange rate. So the fact that we
have a stronger economy, are likely to raise rates sooner, and they
are continuing to ease monetary policy, those factors have tended
to push up the dollar. That has tended to create a drag for net exports and to diminish our growth prospects, and that is something
that affects the stance and appropriate future stance of monetary
policy.
Now, even taking all of that into account, the very significant appreciation we have seen of the dollar, we need to put that in the
context of the overall strength in domestic spending in the U.S.
economy. Our committee concluded that even taking that into account, the continuing drag there, we still think the U.S. economy
is going to grow and will probably remain appropriate.
Senator WARNER. But this will be a factorand my time is up.
Ms. YELLEN. It is a factor
Senator WARNER. This will be a factor the FOMC will look at
since
Ms. YELLEN. Absolutely, always looking at
Senator WARNER. in effect, they are continuing to put all
these burdens on our countrys economy to kind of carry the whole
world forward.
Ms. YELLEN. It is a factor. We are constantly looking at it. That
is essentially what is happening.
Chairman SHELBY. Before I recognize Senator Schumer, I would
like to clarify the record. The bill that was reported out of here, our
banking legislation, back in May does not raise the threshold in
Section 165 of Dodd-Frank to $500 billion, as a lot of people think.
In fact, the legislation keeps the $50 billion threshold in place for
all institutions to be considered for enhanced prudential regulation
and gives the regulatorsthe Fed, generallythe discretion to determine what institutions above $50 billion should be subject to it.
Banks above $500 billion would receive no such discretion. I just
wanted to clear the record on this.
Senator Schumer.
Senator SCHUMER. Thank you, Mr. Chairman
Senator BROWN. Could I speak for a moment?
Chairman SHELBY. Yes, sir, Senator Brown.
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Senator BROWN. While the Chairman technically is correct, the
difficulty for FSOC designation was made much greater, so the
I believe that what Senator Warren said is correct, that it does not
protect the safety and soundness of ourthat legislation can
threaten the safety and soundness of our banking system. I will
leave it at that, and we can debate this for a long time.
Chairman SHELBY. We will.
[Laughter.]
Chairman SHELBY. Senator Schumer.
Senator SCHUMER. Thank you, Mr. Chairman.
Chairman SHELBY. Thank you for your
Senator SCHUMER. No problem. Thank you. And thank you,
Chairman.
As you stated in your testimony, the FOMC will likely look to
raise the Federal funds rate at some point before the end of the
year, and you and the others on the FOMC must ultimately make
this decision, weighing all the information at your disposal. I understand that.
But as we have discussed previously, I am still troubled by sluggish wage growth in America. Along with tepid wage growth, we
continue to see depressed labor force participation, inflation continues to run well below the 2-percent target. So I am left to question whether there is still significant slack in the labor market.
Views may differ here. I have heard from experts on both sides.
But I refuse to let the loud voices of those screaming for the Fed
to act to drown out the voices of middle-class working families who
continue to wait quietly for economic recovery to show up in their
take-home pay. And so the question of when the Fed will raise
rates has received a lot of attention, but as I have said before, I
believe the single biggest problem facing this country is the decline
of middle-class income. And as you know, middle-class incomes
have decreased by 6.5 percent. Median income adjusted for inflation is $3,600 lower than when President Bush took office.
So my question is a simple one: What more can be done? How
can we create better individuals to increase productivity? What do
you see as critical catalysts for stronger wage growth? Because it
almost seems we are pushing on a wet noodle?
Ms. YELLEN. Well, we have seen structural forces over a long period of time push down on middle-class wages, and the economic
research that has been done suggests a continuing high demand for
skilled labor and declining demand for less skilled labor. We see an
increasing wage gap between those who are more skilled and less
skilled, partly reflecting the nature of technological change and
globalization. And productivity growth, as you mentioned, has certainly slowed down since 2007. We point this out in the Monetary
Policy Report. It has been decidedly slower than before that. And
I think it is important to focus on policies that would improve productivity growth. They have to do with making sure that every
American child is able to get a really world-class education and is
really able to succeed in this economy, and that we take actions to
promote innovation and entrepreneurship and capital investment,
both public and private, that are necessary to drive innovation.
I think those are the kinds of policies that Congress and the public need to consider to address these. These are deeper structural
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trends that are not just related to the cyclical state of the economy,
and they have been around for a long time, and it is appropriate
Senator SCHUMER. And there is certainly a limit what monetary
policy
Ms. YELLEN. There is.
Senator SCHUMER. We understand that. But here we are facing
sequestration here in the Congress, and current spending bills proposed by my colleagues on the other side of the aisle would slash
funding for key resourcessupplemental opportunity grants, Pell
grants, $300 million from employment and job training programs,
cuts to education. These are the kinds of programs you mentioned
in part as catalysts to stronger wage growth. So I do not want you
to weigh in on specific programs. Obviously, that is not your job.
But let me ask you this: As we look toward the end of the year,
can you talk about the broader impact to our economic recovery
that drastic, automatically triggered budget cuts may have as well
as the potential for a Government shutdown and the uncertainty
surrounding the debt ceiling? Do you believe these events could create fiscal headwinds for our recovery?
Ms. YELLEN. Well, in recent years, fiscal policy has gone from
creating a significant drag on the economy to being roughly neutral, and that shift in a favorable direction I think has helped to
promote economic recovery. So I would be concerned about something that was a large fiscal shift. I do not know whether or not
this would be. But policies or governmental actions that create uncertainty, whether it is a Government shutdown or running up
against the debt ceiling, that reduce the confidence of households
and businesses on the ability of their Government to function in an
effective way and create fear and loss of confidence obviously are
not helpful to recovery.
Senator SCHUMER. And just getting to the wage growth conundrum, wouldnt cutting education and cutting training programs
that make workers more able to be productive be counter to that?
Ms. YELLEN. So I do not want to, as you indicated, weigh in on
specific programs, but I do think that education programs, programs to promote training and skills acquisition are very critical
in addressing wage inequality.
Senator SCHUMER. Thank you.
Chairman SHELBY. Madam Chair, we thank you again for your
appearance and your willingness to come, and we hope we can
work with you on some of the proposed legislation because I think
there are some misperceptions of what we are trying to do. We are
trying to give you a lot of poweryou already have a lot of power
and some discretion, but none of us wants to weaken the banking
system.
Thank you.
Ms. YELLEN. Thank you, Chair Shelby. I look forward to working
with you and the Committee.
Chairman SHELBY. Thank you. This hearing is adjourned.
[Prepared statements, responses to written questions, and additional material supplied for the record follow:]
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PREPARED STATEMENT OF JANET L. YELLEN
CHAIR, BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
JULY 16, 2015
Chairman Shelby, Ranking Member Brown, and Members of the Committee, I am
pleased to present the Federal Reserves semiannual Monetary Policy Report to the
Congress. In my remarks today, I will discuss the current economic situation and
outlook before turning to monetary policy.
Current Economic Situation and Outlook
Since my appearance before this Committee in February, the economy has made
further progress toward the Federal Reserves objective of maximum employment,
while inflation has continued to run below the level that the Federal Open Market
Committee (FOMC) judges to be most consistent over the longer run with the Federal Reserves statutory mandate to promote maximum employment and price stability.
In the labor market, the unemployment rate now stands at 5.3 percent, slightly
below its level at the end of last year and down more than 412 percentage points
from its 10 percent peak in late 2009. Meanwhile, monthly gains in nonfarm payroll
employment averaged about 210,000 over the first half of this year, somewhat less
than the robust 260,000 average seen in 2014 but still sufficient to bring the total
increase in employment since its trough to more than 12 million jobs. Other measures of job market health are also trending in the right direction, with noticeable
declines over the past year in the number of people suffering long-term unemployment and in the numbers working part time who would prefer full-time employment. However, these measuresas well as the unemployment ratecontinue to indicate that there is still some slack in labor markets. For example, too many people
are not searching for a job but would likely do so if the labor market was stronger.
And, although there are tentative signs that wage growth has picked up, it continues to be relatively subdued, consistent with other indications of slack. Thus,
while labor market conditions have improved substantially, they are, in the FOMCs
judgment, not yet consistent with maximum employment.
Even as the labor market was improving, domestic spending and production softened notably during the first half of this year. Real gross domestic product (GDP)
is now estimated to have been little changed in the first quarter after having risen
at an average annual rate of 312 percent over the second half of last year, and industrial production has declined a bit, on balance, since the turn of the year. While
these developments bear watching, some of this sluggishness seems to be the result
of transitory factors, including unusually severe winter weather, labor disruptions
at West Coast ports, and statistical noise. The available data suggest a moderate
pace of GDP growth in the second quarter as these influences dissipate. Notably,
consumer spending has picked up, and sales of motor vehicles in May and June
were strong, suggesting that many households have both the wherewithal and the
confidence to purchase big-ticket items. In addition, homebuilding has picked up
somewhat lately, although the demand for housing is still being restrained by limited availability of mortgage loans to many potential homebuyers. Business investment has been soft this year, partly reflecting the plunge in oil drilling. And net
exports are being held down by weak economic growth in several of our major trading partners and the appreciation of the dollar.
Looking forward, prospects are favorable for further improvement in the U.S.
labor market and the economy more broadly. Low oil prices and ongoing employment gains should continue to bolster consumer spending, financial conditions generally remain supportive of growth, and the highly accommodative monetary policies
abroad should work to strengthen global growth. In addition, some of the headwinds
restraining economic growth, including the effects of dollar appreciation on net exports and the effect of lower oil prices on capital spending, should diminish over
time. As a result, the FOMC expects U.S. GDP growth to strengthen over the remainder of this year and the unemployment rate to decline gradually.
As always, however, there are some uncertainties in the economic outlook. Foreign developments, in particular, pose some risks to U.S. growth. Most notably, although the recovery in the euro area appears to have gained a firmer footing, the
situation in Greece remains difficult. And China continues to grapple with the challenges posed by high debt, weak property markets, and volatile financial conditions.
But economic growth abroad could also pick up more quickly than observers generally anticipate, providing additional support for U.S. economic activity. The U.S.
economy also might snap back more quickly as the transitory influences holding
down first-half growth fade and the boost to consumer spending from low oil prices
shows through more definitively.
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As I noted earlier, inflation continues to run below the Committees 2-percent objective, with the personal consumption expenditures (PCE) price index up only 14
percent over the 12 months ending in May and the core index, which excludes the
volatile food and energy components, up only 114 percent over the same period. To
a significant extent, the recent low readings on total PCE inflation reflect influences
that are likely to be transitory, particularly the earlier steep declines in oil prices
and in the prices of non-energy imported goods. Indeed, energy prices appear to
have stabilized recently.
Although monthly inflation readings have firmed lately, the 12-month change in
the PCE price index is likely to remain near its recent low level in the near term.
My colleagues and I continue to expect that as the effects of these transitory factors
dissipate and as the labor market improves further, inflation will move gradually
back toward our 2-percent objective over the medium term. Market-based measures
of inflation compensation remain lowalthough they have risen some from their
levels earlier this yearand survey-based measures of longer-term inflation expectations have remained stable. The Committee will continue to monitor inflation developments carefully.
Monetary Policy
Regarding monetary policy, the FOMC conducts policy to promote maximum employment and price stability, as required by our statutory mandate from the Congress. Given the economic situation that I just described, the Committee has judged
that a high degree of monetary policy accommodation remains appropriate. Consistent with that assessment, we have continued to maintain the target range for
the Federal funds rate at 0 to 14 percent and have kept the Federal Reserves holdings of longer-term securities at their current elevated level to help maintain accommodative financial conditions.
In its most recent statement, the FOMC again noted that it judged it would be
appropriate to raise the target range for the Federal funds rate when it has seen
further improvement in the labor market and is reasonably confident that inflation
will move back to its 2-percent objective over the medium term. The Committee will
determine the timing of the initial increase in the Federal funds rate on a meetingby-meeting basis, depending on its assessment of realized and expected progress toward its objectives of maximum employment and 2-percent inflation. If the economy
evolves as we expect, economic conditions likely would make it appropriate at some
point this year to raise the Federal funds rate target, thereby beginning to normalize the stance of monetary policy. Indeed, most participants in June projected
that an increase in the Federal funds target range would likely become appropriate
before year-end. But let me emphasize again that these are projections based on the
anticipated path of the economy, not statements of intent to raise rates at any particular time.
A decision by the Committee to raise its target range for the Federal funds rate
will signal how much progress the economy has made in healing from the trauma
of the financial crisis. That said, the importance of the initial step to raise the Federal funds rate target should not be overemphasized. What matters for financial
conditions and the broader economy is the entire expected path of interest rates, not
any particular move, including the initial increase, in the Federal funds rate. Indeed, the stance of monetary policy will likely remain highly accommodative for
quite some time after the first increase in the Federal funds rate in order to support
continued progress toward our objectives of maximum employment and 2-percent inflation. In the projections prepared for our June meeting, most FOMC participants
anticipated that economic conditions would evolve over time in a way that will warrant gradual increases in the Federal funds rate as the headwinds that still restrain
real activity continue to diminish and inflation rises. Of course, if the expansion
proves to be more vigorous than currently anticipated and inflation moves higher
than expected, then the appropriate path would likely follow a higher and steeper
trajectory; conversely, if conditions were to prove weaker, then the appropriate trajectory would be lower and less steep than currently projected. As always, we will
regularly reassess what level of the Federal funds rate is consistent with achieving
and maintaining the Committees dual mandate.
I would also like to note that the Federal Reserve has continued to refine its operational plans pertaining to the deployment of our various policy tools when the
Committee judges it appropriate to begin normalizing the stance of policy. Last fall,
the Committee issued a detailed statement concerning its plans for policy normalization and, over the past few months, we have announced a number of additional
details regarding the approach the Committee intends to use when it decides to
raise the target range for the Federal funds rate.
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Federal Reserve Transparency and Accountability
These statements pertaining to policy normalization constitute recent examples of
the many steps the Federal Reserve has taken over the years to improve our public
communications concerning monetary policy. As this Committee well knows, the
Board has for many years delivered an extensive report on monetary policy and economic developments at semiannual hearings such as this one. And the FOMC has
long announced its monetary policy decisions by issuing statements shortly after its
meetings, followed by minutes of its meetings with a full account of policy discussions and, with an appropriate lag, complete meeting transcripts. Innovations in recent years have included quarterly press conferences and the quarterly release of
FOMC participants projections for economic growth, unemployment, inflation, and
the appropriate path for the Committees interest rate target. In addition, the Committee adopted a statement in 2012 concerning its longer-run goals and monetary
policy strategy that included a specific 2-percent longer-run objective for inflation
and a commitment to follow a balanced approach in pursuing our mandated goals.
Transparency concerning the Federal Reserves conduct of monetary policy is desirable because better public understanding enhances the effectiveness of policy.
More important, however, is that transparent communications reflect the Federal
Reserves commitment to accountability within our democratic system of Government. Our various communications tools are important means of implementing monetary policy and have many technical elements. Each step forward in our communications practices has been taken with the goal of enhancing the effectiveness of
monetary policy and avoiding unintended consequences. Effective communication is
also crucial to ensuring that the Federal Reserve remains accountable, but measures
that affect the ability of policymakers to make decisions about monetary policy free
of short-term political pressure, in the name of transparency, should be avoided.
The Federal Reserve ranks among the most transparent central banks. We publish a summary of our balance sheet every week. Our financial statements are audited annually by an outside auditor and made public. Every security we hold is listed on the Web site of the Federal Reserve Bank of New York. And, in conformance
with the Dodd-Frank Act, transaction-level data on all of our lendingincluding the
identity of borrowers and the amounts borrowedare published with a 2-year lag.
Efforts to further increase transparency, no matter how well intentioned, must
avoid unintended consequences that could undermine the Federal Reserves ability
to make policy in the long-run best interest of American families and businesses.
Summary
In sum, since the February 2015 Monetary Policy Report, we have seen, despite
the soft patch in economic activity in the first quarter, that the labor market has
continued to show progress toward our objective of maximum employment. Inflation
has continued to run below our longer-run objective, but we believe transitory factors have played a major role. We continue to anticipate that it will be appropriate
to raise the target range for the Federal funds rate when the Committee has seen
further improvement in the labor market and is reasonably confident that inflation
will move back to its 2-percent objective over the medium term. As always, the Federal Reserve remains committed to employing its tools to best promote the attainment of its dual mandate.
Thank you. I would be pleased to take your questions.
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RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN SHELBY
FROM JANET L. YELLEN
Q.1. Many economists have proposed that the Federal Reserve

should adopt a strategy of targeting the growth rate of nominal
GDP, which would create a countercyclical monetary policy to offset
booms and downturns in the economy while also reducing uncertainty.
Does the Federal Open Market Committee (FOMC) consider the
rate of nominal GDP growth as a priority in its monetary policy decisions?
A.1. The Federal Reserves mandate, as established by Congress in
the Federal Reserve Act, is to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest
rates. 1 To assess progress toward these statutory objectives, the
FOMC considers information about a wide range of variables, including the rate of nominal GDP growth. This information encompasses indicators of inflation pressures, measures of labor market
conditions and real economic activity, and readings on financial
and international developments. Nominal GDP growth, by itself,
does not give a complete picture of the economys performance;
moderate nominal GDP growth could reflect, for example, strong
growth of real economic activity with low inflation, or weak economic growth with high inflation.
Q.2. Could the FOMC adopt a strategy of targeting nominal GDP?
A.2. While, conceptually, the FOMC could adopt a strategy of targeting nominal GDP, there are a number considerations regarding
the satisfaction of the Federal Reserves statutory objectives and
the balance of prospective benefits and costs that such strategy
would entail relative to other policy frameworks.
The expression nominal GDP targeting has been used to refer
to two distinct policy strategies. First, a central bank could target
the growth rate of nominal GDP. 2 As pointed out by Bernanke and
Mishkin (1997), and as illustrated by the international experience,
modern inflation targeting frameworks generally allow policymakers ample flexibility to stabilize economic activity in the near
term or to look beyond transitory movements in inflation due to
swings in global energy and trade prices. The research literature
suggests that the macroeconomic outcomes achieved by central
banks pursuing an inflation objective tend to be similar to those
they would have achieved had they targeted the growth rate of
nominal GDP. 3 Second, nominal GDP targeting can be understood
1 The FOMC judges that moderate longer-term interest rates would follow if the Federal Reserve achieves its objectives of maximum employment and stable prices; hence the FOMC often
refers to its statutory objectives as the dual mandate. The FOMC also judges that inflation
at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Federal Reserves statutory mandate. In setting monetary policy, the FOMC seeks to mitigate deviations of inflation
from this 2 percent longer-run goal and deviations of employment from the committees assessments of its maximum level. See Board of Governors (2015), Statement on Longer-Run Goals
and Monetary Policy Strategy, press release, January 27, http://www.federalreserve.gov/
monetarypolicy/files/FOMClLongerRunGoals.pdf.
2 For early arguments in favor of targeting the growth rate of nominal GDP, see Taylor
(1985), What Would Nominal GDP Targeting Do to the Business Cycle? Carnegie-Rochester
Conference Series on Public Policy, Amsterdam: North-Holland, vol. 22, pp. 6184.
3 See Ben S. Bernanke and Frederic S. Mishkin (1997), Inflation Targeting: A New Framework for Monetary Policy? Journal of Economic Perspectives, vol. 11(2), pp. 97116. For arguments that policymakers under inflation targeting regimes afforded considerable flexibility to re-
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as a monetary policy strategy in which the central bank seeks to
stabilize the level of nominal GDP around a preannounced trend
path in order to achieve its longer-run statutory objectives.
Because the difference between nominal GDP and its targeted
value can be expressed as the sum of a price gap and a real activity
gap, nominal GDP targeting recognizes, albeit imperfectly, elements on both sides of the FOMCs dual mandate. 4 At least in theory, monetary policy that targets nominal GDP can help correct the
effects of aggregate demand shocks on both real GDP and the price
level. For instance, under nominal GDP level targeting, the central
bank would respond to a shortfall in the level of nominal GDP by
easing monetary policy to generate a period of above-trend nominal
GDP growth in order to bring nominal GDP back to the original
trend path; that policy easing would increase both real activity and
the price level. A credible expectation that monetary policy will be
accommodative in the future, in turn, helps to mitigate the initial
fall in output and inflation. The theoretical benefits of targeting the
level of nominal GDP hinge on the credibility of the promise to
stimulate the economy down the road, the publics ability to form
accurate expectations of the policy response and its effects, and,
more generally, the publics understanding of the way the economy
operates and interacts with monetary policy.
There are, however, some important practical considerations with
the pursuit of nominal GDP targeting. First, when faced with a
very large fall in nominal GDP, as occurred during the 20082009
recession, a central bank committed to a nominal GDP target
would promise to eventually lower the unemployment rate well
below the natural rate of unemployment and to raise inflation
above its longer-run average for some time in order to lift nominal
GDP back to its targeted level. When that promise comes due, it
is not obvious that the central bank and the public would judge
that running the economy that hotpossibly over a period of several years after the initial shock has come to passis desirable. 5
Second, if the central bank is intent on delivering the promised
period of very low unemployment and temporarily high inflation,
there can be risks to the potency and credibility of monetary policy
from adverse movements in expectations. Once resource slack has
been reabsorbed, the maintenance of monetary conditions that are
sufficiently accommodative to lift inflation above the longer-run objective could be misinterpreted by the public as evidence that the
central bank is not committed to its price stability mandate, thus
heightening the risk that longer-run inflation expectations could
become unanchored.
Third, data on nominal GDP are not available as timely and frequently as, say, data on inflation and the unemployment rate.
Moreover, nominal GDP data are subject to revisions, which can be
spond to the slump in output during the financial crisis, see Ben S. Bernanke (2011), The Effects of the Great Recession on Central Bank Doctrine and Practice, speech delivered at Federal
Reserve Bank of Boston 56th Economic Conference, Boston, Massachusetts, October 18.
4 Output prices cover a broader set of goods and services prices than the index of personal
consumption expenditures that the FOMC uses to assess progress toward its longer-run inflation
objective. Moreover, the real activity gap is only imperfectly related to the gap between employment and the statutory goal of maximum employment.
5 This phenomenon is known as the time-consistency problem. It arises because the benefits
of nominal GDP targeting are frontloaded whereas the costs are postponed and can be avoided
by reneging on the promise.
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large and occur several quarters or even years after the release of
the initial estimates. These revisions directly alter the size of the
gap between current nominal GDP and its targeted level, and so
might call for a change in the stance of monetary policy even if the
public perceives economic conditions as unchanged. Furthermore,
nominal GDP is influenced by a number of nonmonetary factors
such as population growth, the labor force participation rate, the
pace of technological advances, and measurement issues such as
price adjustments for quality changes. Innovations to these nonmonetary factors affect the price level or inflation rate that is consistent with the achievement of a given nominal GDP target. 6 For
all these reasons, the demands on the publics attention and comprehension imposed by nominal GDP targeting are arguably nontrivial.
Q.3. A recent report from the Bank of International Settlements
(BIS) found that the prolonged period of low interest rates is damaging the U.S. economy, resulting in too much debt and too little
growth. In addition, the report states that low rates may in part
have contributed to . . . costly financial booms and busts. Do you
agree with the BIS that persistently low interest rates can have
negative effects on the U.S. economy? Please explain.
A.3. The accommodative monetary policy of the Federal Reserve is
designed to fulfill the dual mandates of maximum employment and
price stability set for us by the Congress. In particular, low interest
rates are currently needed to provide support for a return to full
employment and for inflation to return to the FOMCs longer run
objective over time. When the economy has strengthened, interest
rates will rise in a sustainable way. In particular, the FOMC has
indicated that it anticipates that it will be appropriate to raise the
target range for the Federal funds rate when it has seen some further improvement in the labor market and is reasonably confident
that inflation will move back to its 2-percent objective over the medium term.
However, the Federal Reserve is also mindful that a prolonged
period of low rates could encourage imprudent risk taking by some
investors and eventually undermine financial stability, with negative effects on the U.S. economy. For this reason, the Federal Reserve, on its own and with other domestic and international regulators, has taken steps to boost the resilience of the financial system and has increased its efforts to comprehensively monitor the
financial system for building vulnerabilities and to guide actions to
mitigate those risks.
Q.4. In your previous testimony before this Committee on February
24th, you stated that in the FOMCs monetary policy decisionmaking process, it is useful for us to consult the recommendations
of rules of the Taylor type. We do so routinely, and they are an important input into what ultimately is a decision that requires
sound judgment.
6 Given a fixed nominal GDP target, volatility in these nonmonetary factors thus directly
translates into volatility in the level of inflation consistent with achieving the target. This volatility could conflict with the Federal Reserves statutory mandate of promoting stable prices.
To be sure, the FOMC could offset the effects on inflation of movements in these nonmonetary
factors by adjusting the nominal GDP target. However, occasional adjustments to the target
could create some communication challenges.
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Which monetary policy rules are used by the FOMC?
A.4. The FOMC treats the prescriptions of monetary policy rules as
useful benchmarks for setting the Federal funds rate. Accordingly,
ahead of every FOMC meeting, Federal Reserve staff prepare a discussion of policy prescriptions from several policy rules for the committees consideration. For example, the most recent staff briefing
materials that are available to the public, which cover FOMC meetings in 2009, considered prescriptions from the following five simple rules: the canonical Taylor (1993) rule, the Taylor (1999) rule,
a first-difference rule, an empirical rule approximating past FOMC
behavior, and an estimated forecast-based rule. Those materials
also discussed optimal control policy prescriptions, which are simulations of the path for the Federal funds rate that delivers the
best macroeconomic outcomes given the Federal Reserve staffs
baseline economic outlook and a loss function that considers larger deviations of real GDP from the level consistent with full employment to be appreciably more costly than smaller deviations,
and similarly for deviations of inflation from the longer-run objective and for volatility in the Federal funds rate. 7 In addition,
FOMC discussion of monetary policy rules is informed by in-depth
technical memos and working papers that are periodically prepared
by Federal Reserve staff, as well as by contributions from the academic literature. 8
The FOMC considers the prescriptions of a variety of monetary
policy rules because no single rule has been shown to be fully satisfactory given the complexity of the economy and constantly evolving economic relationships. Many studies have shown that in normal times, when the economy is buffeted by typical shocks, simple
rules can deliver outcomes that are close to those under optimal
policies. However, the simple rules that perform well under ordinary circumstances may disappoint during periods of, say, persistently strong headwinds restraining recovery. 9 Moreover, simple
rules that perform well in some economic environments may perform poorly when economic relationships are unstable, because
such rules do not quickly adapt to changes in potential output
growth or fail to incorporate financial stability concerns in times of
crisis. 10
Q.5. Please submit to us a list of each rule discussed by the FOMC
at its most recent meeting.
7 For an example of policy prescriptions from simple rules and optimal control exercises, along
with a discussion of how they inform policy, see Janet Yellen (2012), Perspectives on Monetary
Policy, speech delivered at the Boston Economic Club Dinner, Boston, Massachusetts, June 6.
Complete model code of the Federal Reserves FRB/US model and illustrative simulation programs, including sample code for optimal control policy, are publicly available on the Federal
Reserves Web site.
8 Some of the staffs technical analysis reviewed by FOMC participants may be made public
in the form of technical working papers, staff notes, and publications in academic journals. For
an illustration of in-depth staff analysis using simple policy rules, including nominal GDP targeting rules, see William B. English, David Lopez-Salido, and Robert J. Tetlow, The Federal
Reserves Framework for Monetary Policy: Recent Changes and New Questions, IMF Economic
Review, vol. 63(1), pp. 2270.
9 For a discussion and an illustration of the shortcomings of simple Taylor-type rules in the
wake of the Great Recession, see Janet Yellen (2012), Revolution and Evolution in Central
Bank Communications, speech delivered at the Haas School of Business, University of California, Berkeley, Berkeley, California, November 13.
10 For studies of rule robustness, see, among others, John B. Taylor and John C. William
(2011), Simple and Robust Rules for Monetary Policy, in John C. Williams, Benjamin Friedman, and Michael Woodford (Eds.), Handbook of Monetary Economics, vol. 3, pp. 829859.
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A.5. Please see response to Question 4.
Q.6. Federal Reserve officials have stated that the Federal Reserves practice of paying interest on banks reserve balances has
become an important tool of monetary policy. If that is the case,
should this rate be set by the FOMC, which is responsible for monetary policy, rather than by the Federal Reserve Board of Governors? Please explain.
A.6. By statute, both the Federal Reserve and FOMC play important roles in the conduct of monetary policy, with the Federal Reserve being responsible for some policy tools and the FOMC being
responsible for the others. The Federal Reserve and FOMC have
worked collaboratively for decades to employ these policy tools in
concert to effectively promote the Federal Reserves long-run goals
of maximum employment and stable prices.
Under the Federal Reserve Act, the Federal Reserve has authority over changes in reserve requirements and on interest on reserves. In addition, any change in the discount rate initiated by a
Federal Reserve Bank is subject to review and determination by
the Federal Reserve. Reserve requirements and the discount rate
have been employed for many years as key elements of the framework that the FOMC has relied upon in managing the level of the
Federal funds rate.
The interest rate paid on banks reserve balances is an important
new tool of monetary policy that is determined by the Federal Reserve. Following the examples of the discount rate and reserve requirements, the Federal Reserve has indicated that the interest on
excess reserves rate will be set in a way to keep the Federal funds
rate in the range established by the FOMC. Indeed, the FOMC
noted in its September 2014 Policy Normalization Principles and
Plans that the Federal Reserve intends to move the Federal funds
rate into the target range set by the FOMC primarily by adjusting
the interest rate it pays on excess reserve balances. The collaborative approach to monetary policy implementation to achieve overall monetary policy objectives was reiterated in the June 2015
FOMC meeting minutes, which noted that operational decisions regarding policy tools will be made in concert by the Federal Reserve
and the FOMC.
Q.7. A Federal judge recently ruled in Starr International Co. v.
U.S. that the actions in the bailout of AIG were beyond the authority of the Federal Reserve since Section 13(3) did not authorize the
Federal Reserve Bank to acquire a borrowers equity as consideration for the loan. The Board of Governors responded in a press
release that its actions in the AIG rescue during the height of the
financial crisis in 2008 were legal, proper and effective.
Did the Federal Reserve conduct a legal analysis to reach this
conclusion?
A.7. A comprehensive legal analysis supporting the conclusion that
the Federal Reserves actions in the American International Group
(AIG) rescue were consistent with all applicable laws can be found
in the United States Post-Trial Brief in the Starr International
court case, filed on March 23, 2015. Starr International Co. v. U.S.,
No. 11-779C, U.S. Court of Federal Claims (Docket No. 434, pages
619). Attached is a copy of that brief, along with two internal Fed-
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eral Reserve memoranda cited in it that relate to the issue of authority (JX13 and DX484). Some other publicly available filings
in this case that also address the authority issue are Docket Nos.
55, 63, 248-1, 279, and 426; these can be found through the Federal
Judiciarys system, Public Access to Courts Electronic Records or
PACER, at www.pacer.gov. As you may be aware, the Department
of Justice has cross-appealed the Court of Federal Claims decision
in Starr, and we expect that the issue of the Federal Reserve s authority will be addressed by the Federal Circuit.
Q.8. Please provide a copy of this analysis and all memoranda and
related documents.
A.8. Please see response to question 5a.
Q.9. Market-based indicators of future economic activity are often
more accurate than research-based predictions.
Does the FOMC use any market-based indicators (such as TIPS
spreads) in its monetary policy decisions?
A.9. The FOMC is firmly committed to fulfilling its statutory mandate of promoting maximum employment and stable prices. The
FOMC recognizes that the inflation expectations of those who set
prices in the economy are an important determinant of the behavior of actual inflation. Consequently, the FOMC monitors both inflation expectations and the actual inflation rate in setting monetary policy.
The FOMC follows various measures of inflation expectations.
One set of measures is based on financial instruments whose payouts are linked to inflation. For example, Treasury inflation protection securities (TIPS)implied inflation compensation (or the TIPS
break even inflation rate) is defined as the difference at comparable
maturities between yields on nominal Treasury securities and
yields on Treasury securities that are indexed to headline CPI inflation (or TIPS). Inflation swapscontracts in which one party
pays a certain fixed amount in exchangefor cash flows that are
indexed to cumulative CPI inflation over some horizonprovide alternative measures of inflation compensation. These market-based
measures provide information about market participants expectations of inflation. However, extracting that information generally
requires the application of economic theory and statistical models
because these market-based measures reflect not only expected inflation, but also an inflation risk premiumthe compensation that
holders of nominal securities demand for bearing inflation riskas
well as other premiums driven by liquidity differences and shifts
in the relative supply and demand of nominal versus inflation-indexed securities. Staff in the Federal Reserve System maintain several term structure models aimed at providing estimates of the inflation expectations and risk premiums that make up inflation compensation but results from those decompositions are sensitive to
model specification.
In addition, the FOMC monitors measures of inflation expectations that are based on surveys of households, market participants,
and professional forecasters. These measures elicit respondents inflation expectations directly, although survey participants are not
necessarily the price setters in the economy.
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As none of available measures of inflation expectations is perfect,
staff in the Federal Reserve System keep track of a wide array of
such measures and continue their efforts to develop deeper understanding of the measures behavior.
Q.10. Does the Federal Reserve have the authority to create a prediction market for economic indicators to help inform its monetary
policy decisions?
A.10. A predictions market is a market where investors purchase
financial contractsfutures or options for examplewith real
funds and the contract payoffs depend on the outcome of events,
such as economic data releases or events. The Federal Reserve Act
does not expressly provide the Federal Reserve with authority to
establish and operate a predictions market. The Federal Reserve
has not considered whether it has inherent authority or authority
under other more general provisions of law to establish and operate
a predictions market.
From time to time, there have been private sector efforts to create prediction markets for economic variables but they have not attracted widespread interest from investors. Indeed, some financial
firms have experimented with running prediction markets for
major economic releases. This information was useful in gauging
market expectations ahead of economic releases but those markets
are no longer active.
More broadly, the Federal Reserve regularly reviews information
from financial markets to gauge market expectations about economic variables such as inflation or the Federal funds rate.
Q.11. If not, what clarification or authorization would be necessary
from Congress to assure the Federal Reserve that predictions markets are an authorized tool for its economic research?
A.11. As noted above, the Federal Reserve regularly reviews financial data to gauge market participants outlook for economic variables such as inflation or the Federal funds rate. If there were actively traded instruments based on other economic variables, the
Federal Reserve would use that information for economic research
and policy analysis as well. The Federal Reserve is not requesting
specific authority to establish and operate a predictions market. In
effect, establishing a predictions market would amount to establishing a futures and options exchange for special types of derivatives contracts. This is an undertaking that would involve many
important operational and policy challenges for the Federal Reserve. Perhaps more importantly, the fact that existing futures and
options exchanges and other large financial institutions have been
unable to launch successful financial contracts of this type suggests
that investor interest in such instruments is limited.
Q.12. On July 20, 2015, the Federal Reserve finalized the GSIB
surcharge proposal. The final rule adopts the proposed rules methodology to identify whether a bank holding company is a GSIB by
considering the institutions size, interconnectedness, substitutability, complexity, and cross-jurisdictional activity. The final rule
states that there is general global consensus that each category included in the BCBS framework is a contributor to the risk a banking organization poses to financial stability. Please explain why
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the Federal Reserve believes that this multifactor approach is an
appropriate way to measure systemic importance.
A.12. The Federal Reserve believes that the multifactor approach
used in the final GSIB surcharge rule (final rule) is appropriate
because it closely aligns with the considerations that the Federal
Reserve may consider under section 165 of the Dodd-Frank Wall
Street Reform and Consumer Protection Act (Dodd-Frank Act). Section 165 of the Dodd-Frank Act (12 U.S.C. 5365) directs the Federal Reserve to implement enhanced prudential standards for certain bank holdings companies and nonbank financial companies. In
prescribing more stringent prudential standards, the Federal Reserve may differentiate among companies on an individual basis or
by category, capital structure, riskiness, complexity, financial activities (including the financial activities of their subsidiaries), size,
and any other risk-related factors that the Federal Reserve deems
appropriate. 11 Similarly, the final rule takes into account leverage,
off-balance sheet exposures, interconnectedness with significant financial counterparties, the nature, scope, size, scale and mix of activities, degree of regulation, and liabilities. Consistent with that
requirement, under the final rule, a firms method 1 and method
2 scores are calculated using a measure of each firms nature,
scope, size, scale, concentration, interconnectedness, and mix of the
activities. Global systemically important bank holding company (G
SIB) capital surcharges are established using these scores, and G
SIBs with higher scores are subject to higher GSIB capital surcharges.
In addition, the Federal Reserve, along with other central banks,
informed and contributed to the preparation of the 2009 Report to
the G20 Finance Ministers and Central Bank Governors, titled
Guidance to Assess the Systemic Importance of Financial Institutions, Markets and Instruments: Initial ConsiderationsBackground Paper (available at http://www.bis.org/publ/othp07b.pdf)
by participating in a comprehensive survey on what factors contribute to the classification of systemic importance. This report
identified size, interconnectedness, substitutability, complexity, and
cross-jurisdictional activity as trends in countries assessments of
systemic importance.
Q.13. It is my understanding that custodial banks have faced increasing difficulty in accepting cash deposits from their clients such
as investment funds and institutional investors, in part due to regulatory requirements that provide disincentive for custodial banks
to hold cash. Nonetheless, custodial banks play an important role
of handling cash for investment funds and now face a multitude of
regulations that inhibit their core activities.
Please provide a copy of any analysis the Federal Reserve has
conducted to evaluate the impact of new regulations on custody
banks ability to accept cash deposits.
Please provide a copy of each analysis conducted by the Federal
Reserve which considers the impact that such regulations would
have on a custody bank during times of financial stress.
Please explain policy rationale for disincentivizing cash holdings
by custodial banks.
11 12
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A.13. I will first respond to your last inquiry, then to the first two.
With regards to part (c), regulatory requirements that have been
established by the Federal Reserve since the financial crisis are
meant to address risks to which banking organizations are exposed,
including the risks associated with funding in the form of cash deposits. The requirements were designed to increase the resiliency
of banking organizations, enabling them to continue serving as financial intermediaries for the U.S. financial system and as sources
of credit to households, businesses, State governments, and low-income, minority, or underserved communities during times of stress.
The supplementary leverage ratio rule (SLR rule), which requires
internationally active banking organizations to hold at least 3 percent of total leverage exposure in tier 1 capital, calculates total leverage exposure as the sum of certain off-balance sheet items and
all on-balance sheet assets. 12 The on-balance sheet portion does
not take into account the level of risk of each type of exposure and
includes cash. As designed, the SLR rule requires a banking organization to hold a minimum amount of capital against on-balance
sheet assets and off-balance sheet exposures, regardless of the risk
associated with the individual exposures. This leverage requirement is designed to recognize that the risk a banking organization
poses to the financial system is a factor of its size as well as the
composition of its assets. Excluding select categories of on-balance
sheet assets, such as cash, from the total leverage exposure would
generally be inconsistent with this principle.
Moreover, in some instances the regulatory requirements regarding liquidity and liquidity risk management provide a favorable
treatment to specific types of cash deposits. For example, the outflow rates for deposits under the Liquidity Coverage Ratio: Liquidity Risk Management Standards rule (LCR rule) are based on factors such as counterparty type and tenor. 13 Relevant to the activities of custodial banks, the LCR rule provides favorable outflow
treatment to operational deposits because the LCR rule acknowledges that these types of deposits exhibit a more stable funding
profile than non-operational funding. 14 To be afforded this favorable treatment, the deposits must meet a set of specific criteria associated with such increased stability. 15 In this way, the LCR rule
takes into account the risk that is inherent in the particular type
of deposit held at the bank.
With regard to parts (a) and (b) of Question 13, as part of several
rulemakings that are applicable to U.S. banking organizations
identified as global systemically important banking organizations
(GSIBs), which includes the largest U.S. custodial banking organizations, Federal Reserve staff estimated the impact that such
rulemakings would have on these firms regulatory capital ratios,
including on the leverage ratio.
12 See 79 FR 57725 (September 26, 2014), available at http://www.gpo.gov/fdsys/pkg/FR2014-09-26/pdf/2014-22083.pdf.
13 See 79 FR 61440 (October 10, 2014), available at http://www.gpo.gov/fdsys/pkg/FR-201410-10/pdf/201422520.pdf.
14 See page 61502 of 79 FR 61440 (October 10, 2014), available at http://www.gpo.gov/fdsys/
pkg/FR-2014-1010/pdf/2014-22520.pdf.
15 See page 61498 of 79 FR 61440 (October 10, 2014), available at: http://www.gpo.gov/fdsys/
pkg/FR-2014-1010/pdf/2014-22520.pdf.
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For example, in April 2014, the Federal Reserve issued a final
rule that would require U.S. top-tier bank holding companies identified as GSIBs to maintain an SLR of more than 5 percent to
avoid restrictions on capital distributions and discretionary bonus
payments to executive officers. 16 Insured depository institutions of
these BHCs must maintain at least a 6 percent SLR to be wellcapitalized under the Federal banking agencies prompt corrective
action framework. Prior to finalizing these requirements, the staff
of the Federal banking agencies, including the Federal Reserve,
analyzed regulatory and confidential supervisory data to determine
the quantitative impact of these rules on subject firms. Federal Reserve staff estimated a tier 1 capital shortfall across U.S. GSIBs
of approximately $68 billion to meet a 5 percent SLR, but all internationally active banking organizations firms were estimated to already meet the minimum 3 percent SLR requirement. 17 The SLR
rule requires public disclosures beginning in 2015, and provides a
transitional period until January 1, 2018, for firms to comply with
these standards. According to their public disclosures, U.S. GSIBs
have made significant progress in complying with the enhanced
SLR standards that take effect in 2018.
As another example, more recently, in July 2015, the Federal Reserve finalized a rule that would implement risk-based capital surcharges for U.S. GSIBs. 18 Federal Reserve staff estimated the
capital surcharges that would apply to the eight U.S. bank holding
companies identified as GSIBs under the final rule. Based upon
these estimates, seven of the eight GSIBs already meet their G
SIB surcharges on a fully phased-in basis, and all such firms are
on their way to meeting their surcharges over the 3-year phase-in
period from January 1, 2016, to fully phased in on January 1, 2019.
Therefore, it is likely that the immediate costs of the final rule on
individual institutions are significantly mitigated by the implementation timeframe. 19
16 See 79 FR 24528 (May 1, 2014), available athttp://www.gpo.gov/fdsys/pkg/FR-2014-05-0l/

pdf/2014-09367.pdf.
17 See Staff memo to the Board Draft Final Rule on Enhanced Supplementary Leverage Ratio
(SLR) Standards; p. 2, available at http://www.federalreserve.gov/aboutthefed/boardmeetings/
20140408openmaterials.htm.
18 See 80 FR 49107 (August 14, 2015), available at http://www.gpo.gov/fdsys/pkg/FR-201508-14/pdf/201518702.pdf.
19 See Staff memo to the Board Draft Final Rule Regarding Risk-Based Capital Surcharges
for Systemically Important U.S. Bank Holding Companies; p. 9, available at http://
www.federalreserve.gov/aboutthefed/boardmeetings/board-memo-gsib-20150720.pdf.
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RESPONSES TO WRITTEN QUESTIONS OF SENATOR CRAPO
Q.1. I submitted a question for the record at your last hearing that
focuses on the Federal Reserves waiver authority under the advanced approaches regulation. In the response, you noted there
were five criteria against which the Federal Reserve would judge
a waiver application. Please provide information on how you define
those criteria and how you would apply them.
A.1. As set forth in the advanced approaches risk-based capital
rule (the advanced approaches rule), the Board of Governors of the
Federal Reserve System (Board) may determine that the application of the advanced approaches rule to a particular firm is not appropriate in light of the firms asset size, level of complexity, risk
profile, or scope of operations. 1 Based on these criteria, the Board
has exempted from, or determined not to apply, the advanced approaches rule to two State member banks, certain U.S. subsidiaries
of foreign banking organizations, and GE Capital Corporation
(GECC).
Exemption for Two State Member Banks
The Board has exempted from the advanced approaches rule two
special purpose State member banks that were subsidiaries of bank
holding companies. 2 In each case, the State member bank was subject to the advanced approaches rule because the parent bank holding company was subject to the advanced approaches rule. Each of
the banks had limited credit risk because each engaged in a narrow
range of deposit, loan, and other banking services. One of the
banks was a limited purpose trust bank with no FDIC-insured deposits. The other bank engaged primarily in back-office operations
and maintained very high capital levels. In addition, each banks
total assets represented less than 1 percent of the total consolidated assets of its bank holding company.
In exempting these banks from the advanced approaches rule,
the Board considered the limited activities and operations of the
banks, risks posed by the banks to the overall banking organization, and the enterprise-wide risk-management practices and ongoing implementation of the advanced approaches rule by the holding
company. After the Board granted the exemptions, each of the bank
holding companies continued to be required to capture the risks of
its subsidiary bank in its advanced systems and to hold capital at
the consolidated level against these risks.
Certain U.S. Subsidiaries of Foreign Banking Organizations
The Board also has exempted certain U.S. subsidiaries of foreign
banking organizations from the requirements of the advanced approaches rule. Under the enhanced prudential standards regulation
(Regulation YY, 12 CFR part 252), a foreign banking organization
with U.S. nonbranch assets of $50 billion or more is required to
form or designate a U.S. intermediate holding company (IHC) to
1 12
CFR 217.100(b)(2).
2 The advanced approaches rule applies to a State member bank that has total consolidated
assets equal to $250 billion or more, that has consolidated total on-balance sheet foreign exposure equal to $10 billion or more, or that is a subsidiary of a holding company or depository
institution that is subject to the advanced approaches rule. See 12 CFR 217.100(b)(1)(ii).
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hold its interests in its U.S. subsidiaries. 3 While an IHC is generally subject to the same risk-based and leverage capital rules
that apply to a bank holding company, the IHC is not required to
comply with the Boards advanced approaches rule. 4 Prior to IHC
formation, a bank holding company that is a subsidiary of a foreign
banking organization and that currently is subject to the advanced
approaches rules may, with the Boards prior written approval,
elect not to comply with the advanced approaches rule. 5
As with the exemptions for the two limited purpose State member banks, the risks of the IHCs are captured in the consolidated
capital requirements and risk management systems of its parent
foreign banking organization. In addition, each IHC will remain
subject to the Boards standardized risk-based capital rules, leverage capital rules, and capital planning and supervisory stress testing requirements.
GECC
Section 165 of the Dodd-Frank Wall Street Reform and Consumer Protection Act generally requires the Board to apply enhanced prudential standards, including risk-based capital requirements, to nonbank financial companies supervised by the Board. 6
In the case of GECC, the Board applied the same risk-based capital
requirements that apply to bank holding companies, except for the
advanced approaches rule. 7 In particular, as noted in the Boards
draft order applying enhanced prudential standards to GECC, the
advanced approaches rule requires the development of models for
calculating advanced approaches risk-weighted assets, and can require a lengthy parallel run period of no less than four consecutive
calendar quarters during which the firm must submit its models
for supervisory approval. 8 While GECC exceeds the threshold for
application of the requirements that apply to advanced approaches
banking organizations, GECC had not previously been subject to
regulatory capital requirements and had not developed the infrastructure and systems required to begin calculating its capital ratios under the advanced approaches rule. 9 Moreover, GECC is undergoing a substantial reorganization. The Board determined to
apply to GECC the same minimum capital requirements that apply
to all bank holding companies under the Boards Regulation Q (12
CFR part 217) through December 31, 2017, and the Boards regulatory capital framework applicable to advanced approaches banking organizations, except for the advanced approaches rule, thereafter unless GECC is no longer designated for Board supervision at
that time. 10
Other Firms
In determining whether to apply the advanced approaches rule
to other firms, the Board would, in each case, make a determina3 See
12 CFR 252.153.
CFR 252.153(e)(2)(i)(A).
CFR 252.153(e)(2)(i)(C).
6 12 U.S.C. 5365.
7 79 FR 71768, 71772 (Dec. 3, 2014).
8 Id. The Board referenced these considerations in the final order applying enhanced prudential standards to GECC. See 80 FR 44111, 44117 (July 24, 2015).
9 79 FR at 71772.
10 See 80 FR at 44125.
4 12
5 12
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tion based on the relevant facts and circumstances, consistent with
the safety and soundness of the firm. As shown in these examples,
this would include, among other things, consideration of the firms
size, complexity, risk profile, and scope of operations, including its
capacity to implement the advanced approaches rule; a balancing
of the cost to implement advanced approaches systems against the
added risk management value; whether the firms risks are captured by a parent banking organizations systems; and other relevant facts.
RESPONSES TO WRITTEN QUESTIONS OF SENATOR VITTER
Q.1. Ms. Yellen, is the Federal Reserve Board involved in negotiating international insurance standards for entities beyond those
you supervise?
A.1. The Federal Reserve participates in the International Association of lnsurance Supervisors (IAIS) as the supervisor of nonbank
systemically important financial institutions and savings and loan
holding companies with significant insurance activities. Along with
members from the Federal Insurance Office and the National Association of lnsurance Commissioners, we advocate for the development of international standards at the IAIS that meet the needs
of the our domestic insurance market and consumers. Standards
developed at the IAIS are not self-executing, or binding on the U.S.
insurance companies unless adopted by the appropriate U.S. regulators in accordance with applicable domestic laws and rulemaking
procedures. The IAIS standards could apply to entities that we do
not supervise if they were adopted as law or regulation by the appropriate authorities in a particular jurisdiction. This is true of all
supervisors who participate at the IAIS since no insurance supervisor has global authority.
RESPONSES TO WRITTEN QUESTIONS OF SENATOR HELLER
Q.1. During your July 15, 2015, testimony in the House Committee
on Financial Services you briefly indicated some vagueness on the
path forward regarding the development of domestic insurance capital standards for companies in the United States. On April 1,
2015, you wrote a letter to me stating: we are committed to inviting public comment on a draft proposal through a formal rulemaking process. I request your confirmation that it is your final
decision to develop domestic insurance capital standards through
formal rulemaking and public comment and not by an order.
A.1. Thank you for the opportunity to clarify. The response provided to you in my letter dated April 1, 2015, is accurate. We are
committed to a formal rulemaking process in the development of a
domestic insurance capital standard. Issuance of a final rule will
commence after we assess the feedback given during the Notice of
Proposed Rulemaking.
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RESPONSES TO WRITTEN QUESTIONS OF SENATOR SASSE
Q.1. In 2013, Senator Crapo asked then Chairman Bernanke to list

bipartisan financial regulatory reforms that Congress should consider enacting. Bernanke responded by mentioning end-user issues,
the swaps push out, and regulatory relief for small financial institutions. Certainly everyone can agree that Dodd-Frank is not perfect. Can you list bipartisan financial regulatory reforms that you
believe Congress should enact?
A.1. The core Dodd-Frank Act and Basel III reforms have made the
global and U.S. financial systems more resilient. These core reforms include much stronger capital requirements and stress testing for large banking firms; strong liquidity requirements for large
banking firms; a new resolution regime for systemically important
financial institutions (SIFIs) and improvements to the resolvability
of SIFIs; central clearing and margin requirements for over-thecounter derivatives; and the creation of the Financial Stability
Oversight Council.
I believe these reforms have made the financial system significantly more stable, but we have more work to do. Some of the remaining steps include: (i) finalization of a few remaining DoddFrank Act reforms, such as swap margin rules and singlecounterparty credit limits for large bank holding companies; implementation of the Net Stable Funding Ratio (NSFR) in the United
States to reduce risks from short-term wholesale funding in our
banking system; and continued improvements to the resolvability
of our largest and most complex firms, including through issuance
by the Board of a long-term debt proposal and continuing work by
the Board and the FDIC to improve resolution planning by these
firms.
The Board has supported targeted financial regulatory reforms in
the past few years, including amendments to the Dodd-Frank Act
provisions that address treatment of end users in the swap margin
rules and changes to the Collins Amendment of the Dodd-Frank
Act to better enable the Board to design capital requirements for
insurance holding companies as well as provisions to expand the
scope of coverage of our Small Bank Holding Company Policy
Statement. The Board continues to support additional targeted relief for small banking organizations, such as exempting banking
firms with less than $10 billion in assets from the Volcker rule and
the incentive compensation provisions of the Dodd-Frank Act. As I
have previously stated, I would also support a modest increase in
the $50 billion threshold in section 165 of the Dodd-Frank Act, so
long as such modest increase did not reduce the Boards authority
to apply an appropriate set of prudential standards on any firms
that fell below the new threshold.
Q.2. Im very concerned about the troubling developments in
Greece, including their inability to keep their fiscal house in order.
Over the long-term horizon, are there parallels that exist now or
that could develop between the United States and Greece that
would trouble you? What steps could we take now to prevent these
parallels from developing?
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A.2. Greeces current fiscal and economic situations are difficult.
However, there are no real parallels between Greece and the
United States. Greeces precarious fiscal position prior to the crisis
left it ill-equipped to use fiscal policy to buffer the effects of the recession, which was particularly problematic as Greece could not
avail itself of its own monetary policy because it is a member of the
euro area. In addition, its access to financial markets was hampered by a lack of trust in Greek fiscal institutions. It is important
to note that Greeces troubles reflect much more than just its fiscal
position. In sum, the events in underscore the value of sound structural policies, Government finances, and macroeconomic institutions.
Q.3. My understanding is that the Financial Stability Boards proposed methodologies for designating asset manager companies and
mutual funds as GSIFIs, as proposed in the FSBs March 2015 report, Assessment Methodologies for Identifying Non-Bank NonInsurer Global Systemically Important Financial Institutions uses
size thresholds that singles out only U.S. entities. Is this true and
is there a risk that designating only U.S. entities would create competitiveness concerns for the U.S.?
A.3. Under the March 2015 report of the Financial Stability Board
(FSB), materiality thresholds would be used to provide an initial
filter of nonbank, non-insurance (NBNI) entities that would be subject to further analysis to determine whether such entities should
be designated as NBNI global systemically important financial institutions (NBNI GSIFls). Thus, while NBNI entities that exceed
the thresholds would be subject to further analysis, they would not
necessarily be designated as NBNI GSIFIs. It is important to note
that none of the thresholds are tied to a firms place of domicile or
incorporation; an entity from any jurisdiction could qualify for further analysis.
The March 2015 proposal described two possible materiality
thresholds that could be used exclusively or in combination to
evaluate asset management companies. Under the first option, an
asset manager would be subject to further assessment if its balance
sheet exceeded a particular threshold (e.g., $100 billion). Under the
second option, an asset manager would be subject to further assessment if it had more than a particular amount of assets under management (e.g., $1 trillion).
Two possible materiality thresholders were also proposed for traditional investment funds. Under the first option, a traditional investment fund would be subject to further assessment if (1) its net
asset value (NAV) exceeded $30 billion and it had balance sheet leverage of three times NAV or (2) the assets under management of
the fund exceeded $100 billion. Under the second option, a traditional investment fund would be subject to further analysis if its
gross assets under management exceeded $200 billion, unless it
can be demonstrated that the fund is not a dominant player in relevant markets.
On July 30, 2015, the FSB announced that it will wait to finalize
the assessment methodologies for NBNI GSIFIs until further
work on financial stability risks from asset management activities
is completed. This will allow further analysis of potential financial
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stability issues associated with asset management entities and activities to inform the revised NBNI methodology.
Q.4. I am concerned that international regulators do not understand the unique aspects of our financial system. For example,
Basel IIIs capital framework severely limits the amount of mortgage servicing asset banks can hold without paying a significant
capital charge. Many think it doesnt make sense to draw such an
arbitrary line, especially when it comes at such a cost to community banks. Banks in my State tell me that the Basel III negotiators ignored or failed to understand the important role of community banks in the United States financial system. Thats cause
for deep concern. Are there areas where you believe the FSB has
ignored or failed to understand aspects of our U.S. financial system, for example in Basel IIIs treatment of community banks?
A.4. The Federal Reserve recognizes the critical role community
banking organizations play in the U.S. economy, and the revised
regulatory capital rule (rule) puts in place a regulatory regime that
takes into account their business model and economic function, as
well as the reduced risks to U.S. financial stability presented by
community banks.
Prior to issuing the final rule, the agencies conducted a pro
forma impact analysis as of March 31, 2012. The analysis, which
incorporated the rules revised treatment of mortgage servicing assets (MSAs), indicated that more than 90 percent of bank holding
companies with assets under $10 billion that met the existing capital requirements at the time would meet the minimum common
equity tier 1 (CET1) capital ratio of 412 percent and that more
than 80 percent of such bank holding companies would meet the
fully phased-in common equity plus capital conservation buffer
level of 7 percent. 1 Based on data publicly reported from these institutions on the Consolidated Financial Statements for Holding
Companies (FR Y-9C), as of July 31, 2015, more than 95 percent
of these bank holding companies would exceed a 7 percent CET1
capital ratio. 2
With regard to MSAs in particular, as noted in the preamble to
the final rule, the Federal banking agencies capital rules have long
limited the inclusion of MSAs and other intangible assets in regulatory capital. This is because of the high level of uncertainty regarding the ability of banking organizations to realize value from
these assets, especially under adverse financial conditions.
Under the final rule, certain deferred tax assets (DTAs) arising
from temporary differences, MSAs, and significant investments in
the capital of unconsolidated financial institutions in the form of
common stock are each subject to an individual limit of 10 percent
of CET1 capital elements and are subject to an aggregate limit of
15 percent of CET1 capital elements. The amount of these items in
excess of the 10 and 15 percent thresholds are to be deducted from
1 See Attachment A FRB Impact, Methodology, and Assumptions to Michael S. Gibsons testimony on Basel III before the Committee on Banking, Housing, and Urban Affairs on November
14,
2012,
available
at
http://www.federalreserve.gov/newsevents/testimony/
gibson20121l14a2.pdf. The final rule implementing the Regulatory Capital Rules, 78 FR 62018
(October 11, 2013) is available at: http://www.gpo.gov/fdsys/pkg/FR2013-11-29/pdf/201327082.pdf.
2 FR Y-9C data is publicly available from the National Information Center, available at:
http://www.ffiec.gov/nicpubweb/nicweb/nichome.aspx.
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CET1 capital. Amounts of MSAs, DTAs, and significant investments in unconsolidated financial institutions that are not deducted due to the aforementioned 10 and 15 percent thresholds
must be assigned to the 250 percent risk weight. 3
The rules treatment of MSAs contributes to the safety and
soundness of banking organizations by mitigating against MSA
market value fluctuations that may adversely affect banking organizations regulatory capital base.
Moreover, the financial crisis demonstrated that the liquidity
in the form of sales, exchanges, or transfersof MSAs may become
unreliable at a time when banking organizations are especially in
need of such liquidity. Furthermore, the Federal Deposit Insurance
Corporation, as receiver of failed insured depository institutions,
has generally found MSAs to be unmarketable during periods of
adverse economic and financial conditions for a variety of reasons
related to the size of the mortgage portfolio and contingent liabilities arising from selling representations and warranties associated
with MSAs. 4
The Federal Reserve is mindful of community banking organizations concerns about aggregate regulatory burden, including both
safety and soundness and consumer regulation. In that regard, several elements of the revised capital rule only apply to large banking organizations and do not apply to community banking organizations. Specifically, banking organizations that qualify as advanced
approaches Board-regulated institutions (those with $250 billion or
more in consolidated total assets or $10 billion or more in consolidated total on-balance-sheet foreign exposures) are subject to the
countercyclical capital buffer, supplementary leverage ratio, capital
requirements for credit valuation adjustments, and disclosure requirements. 5 Banking organizations with trading assets and liabilities of at least $1 billion or 10 percent of its total assets are subject to market risk capital requirements. 6 Community banking organizations also are not subject to the enhanced standards that
larger bank holding companies face related to capital plans, stress
testing, liquidity and risk management requirements, and the global systemically important banking organization surcharge. In addition, consistent with recent statutory changes, the Federal Reserve
expanded the applicability of its Small Bank Holding Company Policy Statement, which has the effect of exempting virtually all bank
holding companies and savings and loan holding companies with
less than $1 billion in total consolidated assets from the Federal
Reserves regulatory capital rules. 7
Q.5. Securities and Exchange Commissioner Dan Gallagher recently argued that it remains the height of regulatory hubris to
assume that not only is there a single regulatory solution to any
3 See 79 FR 62018 (October 11, 2013), available at http://www.gpo.gov/fdsys/pkg/FR-201311-29/pdf/201327082.pdf. See also Final Rule on Enhanced Regulatory Capital Standards
Implications for Community Banking Organizations, available at http://www.gpo.gov/fdsys/
pkg/FR-2013-11-29/pdf/2013-27082.pdf.
4 See 79 FR 62018 (October 11, 2013), available at http://www.gpo.gov/fdsys/pkg/FR-201311-29/pdf/201327082.pdf.
5 Id.
6 See 78 FR 76521 (December 18, 2013), available at http://www.gpo.gov/fdsys/pkg/FR2013-12-18/pdf/201329785.pdf.
7 See 80 FR 20153 (April 15, 2015) available at: http://www.gpo.gov/fdsys/pkg/FR-2015-0415/pdf/201508513.pdf.
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given problem facing our markets, but that a handful of mandarins
working in an opaque international forum can find those perfect solutions. He argues that when regulators get things wrong, they
risk things going wrong everywhere because of the regulatory
international cooperation. He cites Basels classification of residential mortgage backed securities as lower-risk as an example, which
partially led to the housing bubble and subsequent financial crisis.
Given this example, is there a risk that increasing international
regulations actually increases systemic risk by creating a firm homogeneity thats shaped by regulation?
If firms are all subjected to similar regulatory standardsa onesize-fits-all approachwont their balance sheets end up looking
the same, and thus subject to the same risk?
A.5. It is important for financial regulation to be tailored to the
business mix, risk profile, size, and systemic footprint of individual
financial firms.
The Federal Reserve is a strong supporter of gradating the stringency of supervision and regulation to the size and systemic footprint of individual banking firms. And we have been doing what we
can with our existing legal authority to do that kind of tailoring,
including with respect to the enhanced prudential standards for
large bank holding companies in section 165 of the Dodd-Frank
Act. We have already done quite a bit of tailoring in this area to
make sure that the most systemic banking firms are subject to a
much tougher regulatory and supervisory framework than regional
banking firms, and we are analyzing whether there is more that
we can do.
The Federal Reserves commitment to regulatory tailoring is also
manifest in our support of Congressional efforts to modify the Collins Amendment in the Dodd-Frank Act to better enable us to design a regulatory framework for insurance holding companies that
is appropriately tailored to the business of insurance. We appreciate the work of Congress to give us this flexibility through the
passage of The Insurance Capital Standards Clarification Act of
2014. Similarly, we would not support any international insurance
capital standard that is not appropriately tailored to the business
of insurance.
The Federal Reserve participates in various international standard setting and policymaking bodiesincluding the Basel Committee on Banking Supervision (BCBS), the Financial Stability
Board (FSB), and the International Association of Insurance Supervisors (IAIS). Our work in these organizations is designed in significant part to achieve greater comparability across jurisdictions
in the core prudential supervisory and regulatory frameworks that
apply to internationally active financial firms. Well-designed international prudential frameworks for large, globally active financial
firms should promote global and U.S. financial stability, provide a
more level playing field for internationally active U.S. financial
firms, and enhance supervisory cooperation and coordination
among global supervisors. The Federal Reserve is committed in its
international regulatory work to ensure that any global standards
work well for U.S. financial firms and U.S. financial markets.
Moreover, no global standard has binding effect in the United
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States unless and until a U.S. regulatory authority goes through
appropriate domestic notice-and-comment processes.
Q.6. Capital regulations for insurance companies is an important
issue that has a significant impact on insurance policyholders in
my State.
This April, Mark Van Der Weide, Deputy Director for the Federal Reserves Division of Banking Supervision and Regulation, explained that the Federal Reserve supports developing an International Capital Standard (JCS) because it can promote financial
stability and help provide a level playing field for global financial
institutions.
Im concerned that efforts to level the playing field, will level
the field by hurting U.S. insurance companies and their policyholders, by forcing them to comply with Europes overly stringent
insurance regulations. As Dr. Adam Posen recently argued at a
hearing with the Senate Banking Committee, the FSBs efforts to
extend Solvency II, the European Commissions regulation for insurance firms, to global application will be harmful for U.S. insurance policyholders, because it tries to add on capital holding requirements of Government bonds and short-term assets akin to
what is (rightly) required for banks. He goes on to argue that European insurers are now using the FSB to impose it on the U.S.,
Japanese, and other competing insurers.
Are there aspects of Solvency II would be harmful if they were
imposed on U.S. insurers?
Are there other areas where you believe the FSB has ignored or
failed to understand aspects of our State-based insurance regulatory system?
What is the Federal Reserve doing to ensure that international
insurance standards do not encroach on the U.S. State-based insurance system and that other countries dont use the FSB and the
IAIS to impose stringent and senseless regulations on U.S.-based
insurers?
A.6. The Federal Reserve participates as a member of the Financial
Stability Board (FSB) and International Association of Insurance
Supervisors (IAIS). Along with other organizations from the United
States including the Federal Insurance Office and the National Association of Insurance Commissioners, the Federal Reserve advocates for the development of international standards that best meet
the needs of the U.S. insurance market. The details of these international standards are still being determined. The FSBs work to
date has primarily focused on the identification and development
of policy measures for Globally Systemically Important Insurers
(GSIIs) including through the adoption of an assessment methodology built by the IAIS. The IAIS continues to work on developing
policy measures to be applied to GSIIs.
The Federal Reserve would not support any international insurance standard that is not appropriately tailored to the business of
insurance and in the best interest of the United States insurance
market. Aspects of Solvency II that could be problematic include its
reliance on models built by the regulated companies and its accounting systems market value basis.
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The international insurance standards currently under development at the IAIS are not self-executing or binding on the U.S., either at the State or the Federal level. They would only apply in the
U.S. if adopted by the appropriate U.S. regulators in accordance
with applicable domestic rulemaking procedures. The Federal Reserve is working to ensure that any standard adopted allows for
the equitable treatment of U.S.-based insurers operating abroad.
None of the standards are intended to replace the existing legal entity risk-based capital requirements that are already in place within the State-based regulatory regime.
Q.7. Insurance experts have levied a number of criticisms against
the Financial Stability Board as it relates to the international regulatory process. This includes that the FSB designates insurance
companies as globally systemically important before the FSOC designates them as systemically important, concerns about the unaccountable process by which the FSB arrives at its decision to label
global systemically important insurers, the lack of a clear offramp for companies to lose their designation, and the risk that
international regulations undermine our State-based regulatory
system.
What FSOC or FSB reforms are you prepared to support on
these issues?
A.7. The IAIS, in coordination with the FSB, developed a proposed
methodology and framework for measuring the systemic footprint
of global insurers. IAIS made public its proposed designation
framework and methodology for global systemically important insurers (GSIIs) multiple times for public comment. Any insurance
company, and any member of the public, had the opportunity to
comment on the proposal. The Federal Reserve strongly supports
public transparency in the methods and processes that international organizations use to identify systemically important financial firms.
Importantly, IAIS and FSB decisions about the identification of
global systemically important insurers are not binding on the
United States. FSOC makes its own independent decisions on designating nonbank financial firms, using the statutory standards set
forth in the Dodd-Frank Act. I would note that the IAIS and FSB
use a somewhat different standard to make designation decisions
than does the FSOC. The international organizations focus on a
firms global systemic footprint and primarily use an algorithm to
make their decisions, whereas the FSOC focuses on impact on U.S.
financial stability and uses a more judgment-based, firm-specific
approach.
With respect to the FSOC, I am firmly committed to promoting
transparency and accountability in connection with the FSOCs activities. To implement its designation authority, FSOC initially developed a framework and criteria and sought public comments
twice on the framework. After publishing guidance, FSOC began
the process of assessing individual companies from a list of companies that met the quantitative criteria set out in the guidance.
Throughout the fall of 2014, FSOC engaged in outreach to stakeholders regarding the designations process. Based on that outreach,
FSOC identified changes to the designations process that would en-
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able earlier engagement with companies under review and increase
transparency to the public, without compromising the FSOCs ability to conduct its work and protect confidential company information. These new processes went into effect in February. We will
continue to work with the FSOC and the Congress to ensure that
the process for designations is transparent and accountable.
The FSOCs designation of a nonbank financial firm is not intended to be permanent. Dodd-Frank Act provides that FSOC annually review designations to make sure that they remain appropriate, and take into account significant changes at the firms. At
the time of designation, firms are given a detailed explanation as
to the specific factors that led to their designation. Firms can use
that information, as well as the public criteria set forth by FSOC,
to guide their efforts to reduce their systemic footprint.
RESPONSES TO WRITTEN QUESTIONS OF
SENATOR MENENDEZ FROM JANET L. YELLEN
Q.1. Before the financial crisis under President Bush, our country
saw policies of trickle-down economics, focused on tax benefits for
individuals at the top of the distribution and budget cuts for everyone else. The results were predictableincomes grew at the very
top, but stagnated for everyone else.
Then, during the crisis and recession, families in the middle and
at the bottom were hit particularly hard. So for the vast majority
of families, its been a long time since theyve seen a meaningful
raise. Now, our economy is recovering, but we havent reached the
point yet where growth feels truly broad-based.
Like most Americans, I dont begrudge financial success, but Im
concerned when the vast majority of people in our country feel they
are not sharing in economic growth, and when widening disparity
makes it harder for ordinary working families to move up the ladder.
In balancing the Feds dual mandate of creating jobs and fighting
inflation, how does the Fed account for the very different ways
Americans are experiencing the same economy, depending on
where they are on the income and wealth spectrum?
A.1. The Congress has instructed the Federal Reserve to pursue a
dual mandate, which involves promoting both maximum employment and price stability. Generally speaking, these objectives pertain to the overall national situation. The Federal Reserve will aim,
to the best of its ability, to deliver the strongest labor market consistent with its 2 percent inflation objective. In doing so, we will
be setting the best possible macroeconomic backdrop for all groups
to attain the greatest prosperity that can be sustained. To be sure,
a range of other policy steps outside the realm of monetary policy
may be appropriate to achieve additional objectives, but such policy
steps are not within the remit of the Federal Reserve.
Q.2. How does the Fed factor in wage history when looking for
signs of when to tighten? Meaning, if average working families
have gone a long period without real wage growth, would that call
for waiting longer to tighten instead of raising rates at the first
sign of an increase?
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A.2. Wage data are one of many sets of indicators that we consult
in determining the appropriate stance of monetary policy. In principle, wage behavior can be informative about both aspects of our
dual mandateprice stability and maximum employment. If wage
growth is weak, that may be a sign both that labor markets are
in a relatively slack condition, and thus that the maximum employment aspect of our mandate is not fulfilled; and it may be a sign
that inflation pressures will be less intense. The symmetric statements could be made if wage growth were strong. That said, many
factors affect wages, including productivity growth, global competition, the nature of technological change, and trends in unionization, that are outside of the Federal Reserves control. For such reasons, wages are but one of many indicators that policymakers consult for evidence of how close or far we are from achieving our dual
mandate.
RESPONSES TO WRITTEN QUESTIONS OF
SENATOR DONNELLY FROM JANET L. YELLEN
Q.1. Chair Yellen, in addition to your comments about the shadow

banking system, are there other developments in the global or domestic economy that you are monitoring for potential risks to financial stability?
Many people are rightly focused on Greece and China, but I
worry about the economic obstacles we do not see coming. Should
we be worried about increasing corporate debt, a liquidity crisis, or
is it something else entirely? In other words, what are the less obvious threats to economic and financial stability that you are
watching closely?
A.1. As you know, since the financial crisis and recession of 2007
2009, we have put in place a comprehensive system to monitor the
financial system for building vulnerabilities. The financial system
and the broader economy will always be buffeted by shocks that
are unexpected or that cannot be mitigated by policymakers, including, as you point out, events abroad. However, the potential for
these shocks to grow and spread is greater when the financial system is more vulnerable. This effect was on full display during the
last recession, when losses on risky mortgages led to problems in
the financial system that ultimately impeded the ability of creditworthy businesses and households to finance investments.
We judge that financial vulnerabilities in the U.S. financial system overall continue to be about where they have been for the past
6 monthsat a moderate level. Factors suggesting that the financial system remains robust include the extremely strong capital
and liquidity positions of the largest banking organizations relative
to recent history and modest debt growth among households.
Among factors suggesting increasing vulnerabilities are, as you
pointed out, the continued rapid clip of borrowing by lower-rated
businesses and stretched valuations among a number of assets, including commercial real estate.
Liquidity has indeed been an issue raised by policymakers, market participants, academics and others. In particular, the concern
is that liquidity, especially in fixed-income markets, is now more
likely to deteriorate significantly even under moderate stress. How-
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ever, a variety of metrics do not suggest a deterioration in day-today liquidity, with some mixed evidence that may point to less resilient liquidity. This evidence is described in greater detail in
Julys Monetary Policy Report. 1 In addition, on July 13, 2015, the
Federal Reserve, together with the Commodity Futures Trading
Commission, the Securities and Exchange Commission, and the Department of Treasury published a joint report examining the events
in the Treasury market on October 15, 2014an episode when
Treasury yields moved dramatically over a brief span of time. 2 The
Federal Reserve, together with other financial regulatory agencies,
is continuing to study and monitor developments in market liquidity.
1 See
http://www.federalreserve.gov/monetarypolicy/files/20150715lmprfullreport.pdf.
http://www.treasury.gov/press-center/press-releases/Documents/
JointlStafflReportlTreasuryl10-15-2015.pdf.
2 See
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Senate Hearing, 114TH Congress - Federal Reserve's Second Monetary Policy Report For 2015

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Senate Hearing, 114TH Congress - Federal Reserve's Second Monetary Policy Report For 2015

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S. HRG.

FEDERAL RESERVES SECOND MONETARY POLICY

JULY 16, 2015

U.S. GOVERNMENT PUBLISHING OFFICE

For sale by the Superintendent of Documents, U.S. Government Publishing Office

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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

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Opening statement of Chairman Shelby ................................................................

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FEDERAL RESERVES SECOND MONETARY

OPENING STATEMENT OF CHAIRMAN RICHARD C. SHELBY

Chairman SHELBY. The Committee will come to order.

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Senator BROWN. Thank you, Mr. Chairman, and welcome back to

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Ms. YELLEN. Thank you. Chairman Shelby, Ranking Member

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